Break-even point

What it is and why it matters

The break-even point is the sales volume at which revenue equals expenses: you neither win nor lose, and you no longer have to keep putting money into the business.

From that point on, every extra dollar of sales contributes to profit. With the same formula you can work out how much to sell to earn what you want.

The formula

• Net sales = gross sales − taxes
• Tax rate = gross sales ÷ net sales
• Variable cost rate = variable costs ÷ net sales
• Contribution rate = 1 − variable cost rate
• Break-even point = fixed costs ÷ contribution rate
• Sales for a profit = (fixed costs + profit before tax) ÷ contribution rate
• Gross sales = net sales × tax rate

What each value means

Variable costs

Costs that go up and down with sales: raw materials (the cost of goods consumed).

Fixed costs

Costs that don't depend on sales volume in the short term: staff, rent, utilities, amortization, fees.

Contribution rate

The share of each dollar of net sales left to pay fixed costs and generate profit.

Step by step

1. Work out net sales by subtracting taxes.
2. Work out the tax rate and the variable cost rate.
3. Work out the contribution rate.
4. Divide the fixed costs by the contribution rate.
5. For a target profit, add it (before tax) to the fixed costs before dividing.
6. Multiply by the tax rate to get gross sales.

Worked examples

Study notes

• Common mistake

  Use the profit before income tax: if you enter the net profit you fall short, because that profit still has to pay the tax.

• Rounding

  If you round the rates (for example, contribution 0.60 and tax rate 1.42), the results shift a little: the calculator uses the exact values.

• Tip

  The contribution margin shows quickly how raising or lowering costs or prices affects results, without rebuilding the whole income statement.