Break-Even Analysis

Break-even analysis answers the critical question: "How much do I need to sell before I start making money?" It's essential for pricing decisions, business planning, and understanding your risk.

Break-Even Formula:

**Break-Even Point (Units) = Fixed Costs ÷ (Price per Unit

• Variable Cost per Unit)**

Or:

Break-Even Point ($) = Fixed Costs ÷ Contribution Margin Ratio

Key Terms:

Fixed Costs: Expenses that don't change with sales volume

• Rent, salaries, insurance, software subscriptions
• Example: $10,000/month (same if you sell 0 or 10,000 units)

Variable Costs: Expenses that increase with each unit sold

• Materials, shipping, packaging, sales commissions
• Example: $15 per unit sold

Contribution Margin: Revenue per unit minus variable cost per unit

• What each sale contributes toward covering fixed costs and profit

Example 1: Simple Product Business

Sell handmade jewelry:

• Price per necklace: $50
• Cost to make each necklace: $15 (materials)
• Monthly fixed costs: $3,500 (rent, utilities, equipment)

Contribution margin: $50 - $15 = $35 per necklace

Break-even units: $3,500 ÷ $35 = 100 necklaces/month

Meaning: Must sell 100 necklaces before making ANY profit. Necklace #101 is where profit starts.

Break-Even Revenue: 100 units × $50 = $5,000/month revenue needed

Example 2: Coffee Shop

Business Details:

• Average sale: $6 per customer
• Variable costs: $2 per customer (coffee beans, milk, cup, etc.)
• Fixed costs: $12,000/month (rent, salaries, utilities, insurance)

Contribution margin: $6 - $2 = $4 per customer

Break-even customers: $12,000 ÷ $4 = 3,000 customers/month

Daily: 3,000 ÷ 30 days = 100 customers/day

If shop serves 80 customers/day → losing money If shop serves 120 customers/day → making profit

Break-Even Chart:

Visualizing the break-even point:

Below break-even (0-99 necklaces):

• Revenue: $0-$4,950
• Total costs: $3,500-$4,985
• Result: Loss

At break-even (100 necklaces):

• Revenue: $5,000
• Total costs: $5,000
• Result: $0 profit, $0 loss

Above break-even (101+ necklaces):

• Revenue: $5,050+
• Total costs: $5,015+
• Result: Profit ($35 profit per additional necklace)

Contribution Margin Ratio:

Formula: Contribution Margin Ratio = Contribution Margin ÷ Price

Jewelry Example:

• Contribution margin: $35
• Price: $50
• CMR = $35 ÷ $50 = 70%

Meaning: 70% of each sale goes toward covering fixed costs and profit.

Use: Break-even revenue = Fixed Costs ÷ CM Ratio

• $3,500 ÷ 0.70 = $5,000 revenue needed

Using Break-Even for Decisions:

1. Pricing Decisions

Current: $50 necklace, 100 break-even units

Option A: Lower price to $45

• Contribution margin: $45 - $15 = $30
• New break-even: $3,500 ÷ $30 = 117 units (17% more sales needed!)

Option B: Raise price to $55

• Contribution margin: $55 - $15 = $40
• New break-even: $3,500 ÷ $40 = 88 units (12% fewer sales needed)

2. Cost Reduction Impact

Current: 100 break-even units

Reduce materials cost from $15 to $12:

• New contribution margin: $50 - $12 = $38
• New break-even: $3,500 ÷ $38 = 92 units (8% fewer sales needed)

3. Expansion Decisions

Considering hiring employee ($2,500/month):

• New fixed costs: $3,500 + $2,500 = $6,000
• New break-even: $6,000 ÷ $35 = 171 units

Question: Can you sell 71 more necklaces/month with the extra help?

4. Safety Margin

How far above break-even are you?

**Safety Margin = (Current Sales

• Break-Even Sales) ÷ Current Sales**

Example:

• Current sales: 150 units/month
• Break-even: 100 units
• Safety margin = (150 - 100) ÷ 150 = 33.3%

Meaning: Sales can drop 33% before you start losing money.

Multi-Product Break-Even:

For businesses selling multiple products:

Weighted Average Contribution Margin:

Coffee Shop Example:

• Coffee: 60% of sales, $4 contribution margin
• Pastries: 40% of sales, $3 contribution margin

Weighted CM: (0.60 × $4) + (0.40 × $3) = $2.40 + $1.20 = $3.60

Break-even: $12,000 ÷ $3.60 = 3,333 items (mix of coffee + pastries)

Break-Even Analysis Limitations:

❌ Assumes constant price: Discounts/sales change contribution margin ❌ Fixed costs aren't always fixed: Rent increases, stepped costs (hire more employees) ❌ Linear relationships: Assumes costs/revenue scale proportionally (economies of scale ignored) ❌ Single product focus: Multiple products complicate analysis ❌ Ignores time: Doesn't account for seasonality or growth

When to Use Break-Even Analysis:

✅ Starting a new business (feasibility check) ✅ Launching new product (pricing decisions) ✅ Considering expansion (hiring, new location) ✅ Evaluating cost changes (supplier negotiations) ✅ Setting sales targets (minimum viable revenue) ✅ Comparing business models (high fixed/low variable vs low fixed/high variable)

Real-World Applications:

SaaS Company:

• Monthly fixed costs: $50,000 (salaries, hosting)
• Price per customer: $100/month
• Variable cost per customer: $10/month (support, hosting per user)
• Contribution margin: $90
• Break-even: 556 customers ($50,000 ÷ $90)

Restaurant:

• Monthly fixed costs: $35,000
• Average check: $40
• Food/labor cost per check: $24
• Contribution margin: $16
• Break-even: 2,188 customers/month (73/day)

E-commerce Store:

• Monthly fixed costs: $8,000
• Average order: $75
• Product cost + shipping: $45
• Contribution margin: $30
• Break-even: 267 orders/month (9/day)

The Bottom Line: Break-even analysis shows the minimum performance needed to avoid losses. Use it for pricing, cost control, and expansion decisions. The goal isn't just to break even—it's to know your floor and build a cushion above it.