Break-even point: how to work out yours

The break-even point is the point at which a business’s revenues exactly match its expenses. That is the British Business Bank’s definition, and it means no profit and no loss.

Below break-even you are losing money on the period. Above it, each extra sale adds to profit. Knowing the figure tells you how much you have to sell before the business pays for itself, which is why it features in most business plans and in many lender conversations.

Fixed costs stay the same whatever you sell, and variable costs rise and fall with the volume you sell. The British Business Bank’s glossary describes fixed costs as costs a company incurs regardless of output volume, usually including rent, interest and salaries.

Some costs are in between. Staff paid per shift or a utility bill with a standing charge plus usage have both elements. Split them into the fixed and variable part where you can, or choose the closer fit and be consistent.

You calculate the break-even point in units by dividing fixed costs by the contribution per unit, where contribution is the selling price minus the variable cost of one unit.

Break-even units = fixed costs ÷ (price per unit − variable cost per unit)

To get the answer in pounds, multiply the units by the price. If you sell a mix of products or services, use the contribution margin ratio instead: contribution divided by sales, expressed as a percentage.

Break-even sales = fixed costs ÷ contribution margin ratio

The contribution margin is not the same as gross profit margin, because gross profit usually takes off only the direct costs of sales, while contribution takes off every cost that varies with volume.

A worked example makes the sum clear. This table uses round, made-up numbers for an imaginary business that sells one product.

In this illustration, the 601st unit in a month is the first that adds to profit. If the business sold 800 units, the 200 units beyond break-even would add £20 each, or £4,000 of profit before tax.

The margin of safety is how far your expected sales are above break-even. It shows how far sales could fall before the business starts to make a loss.

In the illustration, expected sales of £40,000 against a break-even of £30,000 leave a margin of £10,000, or 25% of expected sales. A thin margin means a small dip in sales turns profit into loss. That matters most when you are about to add fixed costs, such as new premises or repayments on a loan.

Your break-even point moves whenever your price, your variable costs or your fixed costs change. You can use that to test decisions before you make them.

• Raising the price increases the contribution per unit, so break-even falls, if customers keep buying.
• Cutting variable costs does the same, for example by changing supplier or reducing waste.
• Cutting fixed costs lowers the amount you need to cover, though some cuts, such as less marketing, may reduce sales.
• Adding fixed costs such as a new lease, a hire or loan repayments raises break-even. Work out the new figure before you commit.

Run the sum with a few scenarios. If a 10% fall in sales takes you below break-even, you know where the risk is.

Seasonal businesses should work out break-even for each season as well as for the year. A café or a garden centre may sit well above break-even in summer and well below it in winter, and the annual figure hides that swing. Our guide to what working capital is explains how to cover the quieter months.

Services work the same way as products. Replace units with billable hours or jobs, work out the contribution from each, and divide your fixed costs by it. A consultancy with £10,000 of monthly fixed costs and £100 of contribution per billable hour needs 100 billable hours a month to break even. That is an illustration of the arithmetic, not a target.

The most common mistake is leaving costs out, which makes break-even look lower than it is. A figure is only as good as the costs and prices behind it.

• Forgetting owner pay, loan repayments, insurance or the cost of your own time.
• Treating a cost as fixed when it rises with volume, or the other way round.
• Using a price you hope to achieve rather than the average you actually receive after discounts.
• Ignoring timing: break-even does not show when cash arrives, so a business can reach break-even and still need working capital.
• Not updating the figure when prices, rent or wages change.

Break-even matters when you borrow because loan repayments are a fixed cost that raises the level of sales you need. Before taking on finance, work out the new break-even figure with the repayments included and check that your sales forecast clears it with room to spare.

Start-ups often reach break-even later than planned. If you are not there yet, read our guide to start up business loans, and see how to write a business plan for where a break-even analysis belongs. If a break-even figure looks too high, look at pricing and costs first, because borrowing does not lower it and a loan adds a fixed cost.

Capzy is a credit broker, not a lender, and is paid by the lender. We do not work out your break-even point for you. If you decide that borrowing makes sense, we introduce you to lenders and set out what comes back so you can compare it, using the lender directory as a starting point.

You can check your funding options with a soft search that does not affect your credit score. A full application to a lender may involve a hard search, and any offer is subject to status and lender criteria. Ask an accountant to check the figures behind a decision to borrow, as Capzy does not give accounting advice.