What is break-even analysis? How to calculate it, why it’s important

Published • 22/05/2024 | Updated • 22/05/2024


What is break-even analysis? How to calculate it, why it’s important

Published • 22/05/2024 | Updated • 22/05/2024


If you’re running a business or considering starting one, getting a handle on break-even analysis is really important. This practical accounting process helps businesses of all sizes pinpoint when revenue covers total costs.

It’s smart to weave break-even analysis into your overall financial planning and business growth strategies, especially when you’re:

  • Thinking about kicking off a new business

  • Getting ready to launch new products or services

  • Working out your pricing strategies 

Whether you’re thinking about setting up a limited company, figuring out how to price a product, or brainstorming things to make and sell from home, this guide to break-even analysis is for you.

We’ll talk through what you need to know, lay out the advantages and disadvantages of break-even analysis, and explain how break-even analysis helps in decision making and allows you to better steer your business.

Depending on the industry, it can take a few years for a startup to hit its break-even point. If you're just starting out, this really highlights the need to keep a tight grip on your small business budget and stay sharp with finances as your business grows.

What is break-even analysis?

Let’s start with the break-even analysis definition. Put simply, it’s about determining the break-even point, which is when your business is neither losing nor making money.

But how can break-even analysis help a business?

For existing enterprises, it helps you figure out how to make extra money by tweaking how you do things to increase profits or manage costs better.

Or, if you’re dreaming up a new venture, it shows you whether your small business ideas are viable and how long it might take before they start paying off. The bottom line is it’s useful in a whole range of scenarios, from launching side hustle ideas to opening a high street shop.

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Benefits of break-even analysis

We’ve already touched on why break-even analysis is important, whether you’re whipping up new recipes in the food and drink industry, stocking the shelves of your shop, or running your enterprise from your spare bedroom. But let’s go into more detail on the key perks.

1. Financial planning and decision-making

Break-even analysis can help you calculate if your idea has a good chance of actually generating you a profit. 

By knowing what it takes to reach break-even point, you can plan more effectively and avoid mistakes, like underestimating costs or ignoring cash flow needs. It also gives you a clear sense of what you need to cover expenses, helping with budget planning and cash flow management.

If you're thinking about adding a new product or service, break-even analysis can help you decide if it’s a good move. It also provides useful data to help you figure out if new investments are worth the extra costs.

2. Pricing strategy and cost reduction

One of the major benefits of break-even analysis is how it helps with pricing. Knowing your break-even point allows you to set prices that cover your costs and make a profit but also stay attractive to customers. It helps you find the right balance between what it costs to make your product and what people are willing to pay.

Break-even analysis can also assist in identifying where to cut costs without cutting corners and compromising on quality. By analysing fixed and variable costs, you can see where savings can be made. For example, a restaurant might cut costs by tweaking portion sizes or switching suppliers.

3. Supporting smart growth and staying proactive

Break-even analysis is a useful tool for growing your business. It shows you when it’s a good time to expand and when it’s better to hold back. With clear financial targets, you can plan your marketing and advertising efforts more effectively and find better solutions to how to scale your business.

By keeping your break-even analysis current, you can stay ahead in a changing market. Regularly revisiting your break-even point helps you adjust to shifting costs or market demand, making your business more flexible and resilient.

Break-even analysis can therefore be a hugely significant part of your business planning and growth strategy. Make it part of your regular bookkeeping for small businesses, and you'll be ready to respond to whatever challenges arise.

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Key components of break-even analysis

Before diving into how to conduct a break-even analysis for your business, let’s run through the key components you’ll need to take into account:

  • Fixed costs

  • Variable costs

  • Selling price per unit

  • Contribution margin

  • Contribution margin ratio

  • Break-even point (BEP)

Fixed costs

Fixed costs are expenses that don’t budge too much, no matter how much you sell

Examples include rent, salaries, vehicle and equipment leases, and subscription fees for your preferred small business accounting tools. If you’re working on online business ideas, consider things like the cost of domains, website hosting, and software licenses.

When it comes to how to calculate fixed cost in break-even analysis, the process is simple. Simply list your fixed costs and add them up.

When it comes to how to calculate fixed cost in break-even analysis, the process is simple. Simply list your fixed costs and add them up.

Variable costs

As the name suggests, variable costs go up and down depending on how much you sell. They might include raw materials, distribution costs, and other production-related expenses.

A small bakery’s variable costs could include ingredients and packaging. For a service business, variable costs might include travel expenses, supplies, or additional hourly wages.

How to calculate variable cost in break-even analysis

To estimate your variable cost per unit:

  1. List all the variable expenses associated with producing your product or delivering your service.

  2. Divide this total by the number of units you plan to produce or services you plan to deliver.

Selling price per unit

Setting the right selling price is essential for reaching your break-even point and making a profit, whether you’re running an established business, exploring ideas for second income streams, or figuring out how to start a business from home

How to calculate selling price in break-even analysis

To get your price right, you need to ensure it covers costs and earns a profit. The selling price should account for variable costs, fixed costs, and your desired profit, and consider your competitors too.

Here’s a quick guide to setting the right price:

  1. Determine variable costs – Calculate the cost of producing each unit, including raw materials and direct labour.

  2. Determine fixed costs – Calculate costs like rent, salaries, and equipment leases. Allocate a portion of these costs to each unit based on expected sales volume.

  3. Add profit margin – Determine your desired profit per unit, and add this to the total cost (variable and fixed).

  4. Research competitor pricing – Compare your calculated price with industry standards and competitor pricing to ensure competitiveness.

  5. Decide on your selling price – Keep in mind that the selling price per unit in break-even calculations refer to the average price. If you offer discounts for buying in bulk, this lowers your average price.

Contribution margin

The contribution margin represents the amount of revenue left over after covering variable costs:

Contribution margin = selling price – variable costs

This money is used to cover fixed costs. Once they’re covered, the leftover contribution margin is profit.

Contribution margin ratio

This ratio shows the percentage of each sale that goes toward covering fixed costs:

Contribution margin ratio = contribution margin / sales revenue

A higher ratio is generally a good thing, because it means you’ll have more money from each product sold to cover other expenses.

Contribution margin ratios can give you a clear overview of the profitability of your products and services. But remember that pursuing the highest possible ratios by sacrificing quality to keep variable costs down can backfire if customers become dissatisfied with your products and services.

Break-Even Point (BEP)

The break-even point is when your revenue equals your costs, indicating you’re not making a profit or a loss. Reaching this point means you’ve avoided losses and are on your way to profitability. Understanding your break-even point helps you set sales targets, adjust pricing, and plan for growth.

How to conduct a break-even analysis

You might be plotting how to start a business, or you may have been running your enterprise for a while. Either way, the same steps are involved in break-even analysis, but what you do with the results will depend on your business goals.

You can determine your break-even point in two ways:

  • By the number of units sold

  • By total sales revenue

Calculating break-even point based on units

This method tells you how many units you need to sell to cover all your costs. To calculate it, subtract variable cost per unit from selling price per unit (your contribution margin), then divide fixed costs by this result.

Fixed costs / (Selling price per unit - variable cost per unit) = units you need to sell to break even

This method is ideal for product-based businesses, so let’s say you’re exploring how to make money from home and plan to launch an online store selling luxury candles.

If your annual fixed costs are £3,000 and variable costs are 50p per candle, with each candle selling for £8, your break-even calculation looks like this:

£3,000 / (£8 - £0.50) = 400

This means you’d need to sell 400 candles in a year to cover your costs and reach the break-even point for your online store.

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Calculating break-even point based on sales revenue

A good match for service-based businesses, this method for determining your break-even point calculates the revenue needed to cover all costs – in other words, the value of sales you need to achieve. This is done by dividing your fixed costs by the contribution margin ratio.

Fixed costs / Contribution margin ratio = sales you need to generate to break even

Say you’re starting a part-time cleaning business. You’ve estimated fixed costs, including basic equipment and insurance, to be £6,000 per year. If you charge £100 for a cleaning session and your variable costs (like detergents and wages for cleaners) total £30, your contribution margin is £70.

Remember, to find the contribution margin ratio, you divide the contribution margin by the sales revenue, in this case £70 / £100, which results in 0.7 (or 70%).

Using the break-even formula, you can determine the sales revenue needed to cover your costs and start making a profit:

£6,000 / 0.7 = £8,571 This means you’d need to generate £8,571 in total sales from cleaning sessions each year to cover your costs and reach the break-even point for your business.

How can a business use break-even analysis?

Once you’ve calculated your break-even point, you can use this information to make better decisions for your business. Here are three key break-even analysis uses that can guide you on the path to profitability.

1. Assess the feasibility of reaching break-even point

Whether it’s a cleaning business or a candle store, assess if your break-even point is achievable. Can you reach that point with your current setup? If not, what changes can you make to get there? If it feels too high, consider adjusting prices or cutting costs. For a new business, it might mean rethinking your business model.

2. Monitor your business’s financial health

Knowing your break-even point is a good way to track how your business is doing. If your actual sales volumes or number of units sold regularly exceed the break-even point, like in the cleaning business making over £8,571, you’re on the right track. Regular break-even analysis means you can keep tabs on your business’s health and growth.

3. Understand your margin of safety

Knowing how much your sales can drop before you reach break-even is helpful. To find out, learn how to calculate margin of safety in break-even analysis.

This simply means subtracting break-even sales from actual sales, then divide the result by actual sales. A higher margin means you’ve got more wiggle room, while a lower one indicates less room to spare.

To keep your business on track, update your break-even analysis every quarter or when there are major changes in your costs, sales, or business setup. Regular check-ins help you stay flexible and adjust to market changes.

How to lower your break-even point

Lowering your break-even point can make it easier for your business to become profitable. There are generally two ways that you can do this:

  • Reduce costs

  • Increase prices

Reducing costs

Reducing costs is a key approach to lowering your break-even point. To help with this, here are 10 effective cost-cutting strategies:

Operate from home

Work from home to eliminate office rent and utility costs from your list of outgoings. This can be especially useful for new businesses with minimal physical space requirements.

Downsize or relocate

If you need a physical location, consider moving to a smaller, more affordable space. This can lower rent and associated costs like energy bills and maintenance.

Renegotiate leases

If you’re locked into a lease, try renegotiating for better terms. You might be able to secure a lower rent or gain more flexibility with your space.

Outsource non-essential tasks

Consider outsourcing tasks like IT support or payroll processing. Using freelancers can be more cost-effective than hiring employees, as you won’t have to cover potentially high salaries, holiday pay and the associated outlay that comes with having full-time staff.

Eliminate unnecessary subscriptions

Review subscriptions like software licenses or memberships. Cancel or downgrade those that you don’t regularly use or that no longer add value to your business.

Manage inventory efficiently

Keep a close eye on your inventory to avoid overstocking or understocking. This can help reduce waste and storage costs.

Buy in bulk

For stable production, buying materials in bulk can save costs. This works best when demand is predictable, helping you get discounts without overstocking.

Streamline processes

Streamline processes as much as possible. This could include using automated invoicing software or refining production processes to cut down on manual labour.

Explore alternative business ideas

Diversifying into low cost business ideas can help offset variable costs. Consider passive income ideas like digital products or services that use fewer raw materials.

Reduce payment processing costs

Evaluate your payment processing setup to identify cost-saving opportunities. Switching to a more affordable provider can lower transaction fees and cut costs.

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Increase your selling price

Raising prices can be an effective way to lower your break-even point, but you need to be careful to avoid losing customers. Here are a few ways to approach this thorny but potentially lucrative option.

Conduct a SWOT analysis

A SWOT analysis considers your business strengths, weaknesses, opportunities, and threats to help you understand where you sit in the market. This gives you insights into your competitive edge and can help you find the best price point to keep your business profitable without driving customers away.

Use market research

Knowing how to conduct market research for a small business in your sector can tell you what customers are willing to pay for your products and services. This can be done through surveys, focus groups, or simply analysing competitor prices. You can use this information to adjust your prices to keep them attractive while also helping to lower your break-even point.

Offer premium products or services

Adding premium options at a higher price can boost your revenue without affecting your regular offerings. This approach appeals to customers who want a little more for their money, allowing you to raise your average price and lower the break-even point for your business.

How to reach your break-even point faster

You know your break-even point, but how can you get there as quickly as possible? Here are some tips for boosting your sales and hopefully entering the zone of profitability more rapidly.

Send promotional emails

Email marketing for small businesses can be a great way to engage with your audience of existing or potential customers. Invite people visiting your website or social media platforms to register their details so you can reach out with newsletters, new product announcements, and more.

Explore creative revenue streams

Find new and creative ways to make money, such as offering gift cards or setting up customer loyalty programs to encourage repeat business. This can increase sales and provide a more stable revenue stream.

Invest in targeted advertising and networking

Improve customer acquisition by focusing on targeted advertising to reach your ideal customers. Consider small business networking too, as working with other businesses can open up new opportunities for customer referrals and collaborations.

Get on social media

Learn how to use social media for small business success so that you can better engage with customers and make your brand better known. Share content that resonates with your target market, run promotions, or simply interact with your customers with comments and conversations.

Train your team

The benefits of training employees properly are wide-ranging. Investing in your team not only improves employee retention rates but can also result in your business offering better customer service. Happier customers are often more inclined to buy.

Invest in the right technology

The right technology can play a big role in boosting sales. Investing in tech like smart point-of-sale systems and portable card readers can streamline customer transactions, making it easier to buy from you.

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Limitations of break-even analysis

Break-even analysis is a valuable tool, but it’s not without its limitations. Whether you’re assessing startup costs for a potential new career or exploring how to start a side hustle, keep these five key drawbacks of break-even analysis in mind.

It doesn’t predict market demand 

Break-even analysis doesn’t provide insights into market demand. This can be a significant limitation, making it really important to do adequate market research for your small business

If you rely solely on break-even analysis without understanding how to identify your target market or the level of customer interest, you risk overproduction or underproduction.

This uncertainty can lead to financial troubles for your business, especially if demand doesn’t meet expectations.

It ignores competition and market trends

Break-even analysis doesn’t factor in competitive forces or market trends. And, if you’re considering new business ideas or product offerings, you need to understand competitors’ strategies.

Not knowing how to do a competitor analysis properly could lead to setting prices that are too high or too low, affecting your ability to attract customers and maintain a steady cash flow.

It can over-simplify costs

While break-even analysis distinguishes between fixed and variable costs, it might not capture all expenses. It assumes costs are constant, but in the real world, they can fluctuate. For example, it doesn’t consider the possibility of your main supplier raising prices, or other unexpected costs that can impact your business.

It doesn’t account for time

Break-even analysis provides a snapshot, but it doesn’t consider the impact of time on your business. Costs and revenues can fluctuate due to seasonal variations or changing customer behaviour.

For instance, if you’re thinking about how to price a service for a gardening business, you’ll need to consider the off-season and how to maintain income throughout the year, not just peak gardening months.

It ignores business risks

Break-even analysis doesn’t address the broader risks involved in running a business. Economic downturns, supply chain disruptions, or changing consumer trends can impact your break-even point and should be part of your planning.

Whether you’re thinking about how to start an online business or setting up a brick-and-mortar shop in your local town, neglecting small business risk management could lead to unexpected financial challenges. Despite its limitations, break-even analysis is a hugely useful tool for planning and decision-making. However, it’s important to use it alongside other strategies, such as creating regular cash flow forecasts, to ensure you’re making the right choices.

Disclaimer: The contents of this page are intended for informational purposes only and should not be construed as professional advice. For matters requiring legal or financial expertise, it’s recommended to seek guidance from qualified professionals.


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