Break-Even Analysis Explained with a Simple Example

The idea in plain words

Some costs do not change with how much you sell, such as rent, fixed salaries and subscriptions. Others rise with each unit, such as materials, packing and delivery. Every sale brings in a price and uses up some variable cost. What is left is the amount that goes towards covering the fixed costs. Break-even is simply the point at which enough of these amounts have been collected to cover all the fixed costs.

Gather three numbers

You need your monthly fixed costs, your selling price per unit, and your variable cost per unit. Be honest about what counts as variable. If a cost grows when you sell more, include it. If it stays flat, it belongs with the fixed group.

The difference between the price and the variable cost per unit is called the contribution per unit. It is the amount each sale contributes towards fixed costs and profit.

• Fixed costs per month
• Selling price per unit
• Variable cost per unit
• Contribution per unit = price minus variable cost

A worked example

For example, imagine a small bakery that sells a gift box. These numbers are hypothetical. Fixed costs are 60,000 a month. The box sells for 500, and the ingredients, packing and delivery for each box cost 300. The contribution per box is therefore 200.

The break-even quantity is fixed costs divided by contribution per unit: 60,000 divided by 200 gives 300 boxes a month. At 300 boxes the bakery covers its costs. At 400 boxes it makes 20,000 above break-even (100 extra boxes at 200 each). At 250 boxes it loses 10,000.

Use it to test decisions

Suppose the owner thinks of giving a discount of 50 per box to attract more orders. Contribution falls to 150, and break-even rises to 400 boxes. The question becomes whether the discount will really bring at least 100 extra boxes a month. Without the calculation, that risk stays hidden.

The same method works in reverse. If the owner can cut variable cost by 20 per box through better buying, the contribution rises to 220 and the break-even falls. Try changing one number at a time and watch what happens.

Know the limits

Break-even analysis is a simplification. It assumes that price and unit cost stay the same at every volume, which is rarely true across big changes. It works best when you sell one product or a mix with similar margins. For several products, calculate with an average contribution or run it separately for each line.

Also check cash, not only profit. You may reach break-even in sales but still run short if customers pay late. Use the result as a guide, and review it when prices, costs or your product mix change.