Your break-even point is the level of sales where your business covers all its costs and makes neither a profit nor a loss. Above it you make money. Below it you lose money.
It is one of the most useful numbers an owner can know, and lenders ask about it often. It tells them how far your sales could fall before you are unable to pay your bills.
The formula
Break-even units = fixed costs ÷ (selling price per unit − variable cost per unit)
The part in brackets is your contribution per unit. It is what each sale adds towards paying your fixed costs.
If you don’t sell in units, use the contribution margin ratio instead:
Break-even sales = fixed costs ÷ contribution margin ratio
Here, the contribution margin ratio = (sales − variable costs) ÷ sales.
Fixed vs variable costs
- Fixed costs stay the same whatever you sell, at least in the short term. Examples are rent, salaried staff, insurance, software subscriptions and loan interest.
- Variable costs rise and fall with each sale. Examples are raw materials, packaging, delivery, sales commission and card fees.
Some costs are a bit of both. Electricity in a factory, for example, has a fixed standing charge and a variable usage charge. Split them as well as you can. You don’t need it to be perfect, but your assumptions should be reasonable.
Worked example: a small bakery
- Fixed costs: $12,000 a month
- Average selling price: $4.00 per item
- Variable cost: $1.60 per item, which covers ingredients, packaging and card fees
- Contribution per item: $4.00 − $1.60 = $2.40
- Contribution margin ratio: $2.40 ÷ $4.00 = 60%
Break-even: $12,000 ÷ $2.40 = 5,000 items a month, which is $20,000 in sales.
If the bakery currently sells 6,500 items a month ($26,000), it has a margin of safety of 1,500 items. That means sales could fall by about 23% before it starts losing money.
Check your own figures with our break-even calculator.
How a new loan changes your break-even
Suppose the bakery borrows money for a new oven, and the loan costs $1,500 a month. The interest is a fixed cost. The repayment of the loan amount (the principal) doesn’t appear in profit, but it still has to be paid in cash.
That is why lenders often look at a cash break-even, which counts the full loan payment:
($12,000 + $1,500) ÷ $2.40 = 5,625 items a month
The margin of safety drops from 1,500 to 875 items, which is about 13%. That gives much less room if sales dip. This is the kind of change a credit analyst will point out, and you should be ready to explain how the new oven increases sales or cuts costs enough to make up for it.
Why lenders care
- Downside protection. A business that is only just above break-even has little room to absorb a bad quarter, a lost customer or a jump in costs.
- Plausible forecasts. If your plan relies on sales far above anything you have achieved before, break-even analysis makes that clear.
- Pricing power. A high contribution margin means each extra sale covers fixed costs quickly. A low margin means you need a lot of volume just to stand still.
Break-even works well alongside the debt service coverage ratio. Break-even tells you how far sales could fall. DSCR tells you how comfortably you can pay your debts at today’s sales.
Ways to lower your break-even point
- Raise prices carefully. A small price rise can make a big difference. In the bakery example, raising the price from $4.00 to $4.20 cuts break-even from 5,000 to about 4,615 items.
- Lower variable costs. Negotiate with suppliers, reduce waste or change your packaging.
- Turn fixed costs into variable ones. For example, use contractors instead of salaried staff, or pay commission instead of fixed fees.
- Sell more of your higher-margin products. Your overall contribution margin rises when more of your sales come from them.
Common mistakes
- Treating owner drawings as optional. If the owner needs to take money out to live on, include it in fixed costs.
- Using one average price for very different products. If your products have very different margins, work out a weighted average contribution margin.
- Forgetting seasonal swings. A business can break even across the year and still run short of cash in its quiet months. Our guide to cash flow vs profit explains why.
Run your own numbers: use our free break-even calculator to check your figures before you speak to your bank.
From the credit desk
What we look for when this comes up in a real credit file:
- We use break-even to judge how much sales can fall before the business stops covering its costs, including loan payments. The wider that safety margin, the more comfortable the credit team is.
- Include debt servicing in fixed costs when you calculate the cash break-even point for a loan application. Many owners leave it out and overstate their margin of safety.
- Projections that need sales far above the historic trend to break even are usually discounted in the credit assessment.
Worked example: Fixed costs of PKR 12 million a year and a contribution margin of 30% give break-even sales of PKR 40 million. If current sales are PKR 55 million, the margin of safety is about 27%.
Sources and further reading
- U.S. Small Business Administration: Plan your business
- IFRS Foundation: IAS 7 Statement of Cash Flows
This article is general information, not financial advice. For decisions on your own business, speak to your accountant or a qualified adviser.
Want to check this for your own business?
Our SME Loan Package Starter Kit calculates your DSCR, ratios and repayment schedule in one Excel file, with a document checklist and proposal outline.
Related guides
- Cash Flow vs. Profit: Why a Profitable Business Can Still Run Out of Money
- DSCR Explained: Formula, What Counts as a Good Ratio, Stress Tests and How Banks Use It
- How Much Can My Business Borrow? The Three Limits Lenders Check
Browse every topic on our All Business Loan Guides page.
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