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Break-Even Analysis

A complete guide to break-even analysis — covering the theory, calculations, charts and what examiners reward.

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Written by an experienced Head of Business and examiner

AQA | Edexcel | Cambridge | Eduqas | WJEC | OCR | GCSE

KEY POINTS

Break-even is the output level where total revenue equals total costs
Contribution per unit = Selling Price minus Variable Cost per Unit
Break-even output = Fixed Costs divided by Contribution per Unit
The margin of safety shows how far sales can fall before a loss is made
Break-even analysis is a useful planning tool but assumes all output is sold

KEY DEFINITION

Break-Even Point

The level of output at which a business's total revenue exactly equals its total costs, resulting in neither a profit nor a loss.

Main Explanation

Break-even is the point where a business sells enough products or services to cover all of its costs. At this point, the business is not making a profit, but it is also not making a loss. It has earned enough revenue to pay for both its fixed costs and variable costs.

Fixed costs are costs that do not change with the level of output, such as rent, salaries or insurance. Variable costs change as output increases, such as raw materials, packaging or delivery costs. The business needs to sell enough units so that the profit made on each item helps cover the fixed costs.

The amount each product contributes towards fixed costs is called the contribution per unit. This is calculated by taking the selling price and subtracting the variable cost per unit. The higher the contribution per unit, the fewer items the business needs to sell to break even.

Break-even is useful because it helps a business understand the minimum level of sales needed to avoid making a loss. It can also help with decisions about pricing, costs, production levels and whether a new product is financially realistic. However, break-even is based on estimates, so it should be used as a guide rather than a guaranteed outcome.

✎ EXAMINER TIP

Always show your working in full. Examiners award method marks even if your final answer is wrong. Label your contribution calculation clearly before dividing into fixed costs.

FORMULA

Break-Even Output = Fixed Costs ÷ Contribution per Unit

Where Contribution per Unit = Selling Price − Variable Cost per Unit

CHART

A break-even chart showing total revenue, total costs and fixed costs plotted against output

✦ WORKED EXAMPLE

Worked Example — Harlow Candles Ltd

Worked Example: Calculating Break-even

A small business sells handmade candles.
Each candle sells for £10.
The variable cost of making each candle is £4.
The business has fixed costs of £1,200 per month.

First, calculate the contribution per candle:

Selling price – Variable cost = Contribution

£10 – £4 = £6

This means each candle contributes £6 towards fixed costs.

Now calculate the break-even point:

Fixed costs ÷ Contribution per unit = Break-even output

£1,200 ÷ £6 = 200 candles

The business needs to sell 200 candles per month to break even.
At this point, the business is making no profit and no loss.
If it sells more than 200 candles, it starts to make a profit.
If it sells fewer than 200 candles, it makes a loss.

DATA TABLE

Break-even data table for Harlow Candles Ltd

DIAGRAM

Placeholder test text for diagram image.

APPLICATION SCENARIO

Break-even at Greggs: deciding whether a new shop is worth opening

Greggs is a useful real-world example because each shop needs to sell enough food and drink every day to cover its costs. Before opening a new branch, Greggs would need to estimate fixed costs such as rent, business rates, equipment, staff wages and utilities. It would then compare these costs with the expected contribution from each sale, such as a sausage roll, sandwich, pizza slice, coffee or meal deal. If the expected number of daily customers is too low, the new shop may take too long to break even.

Break-even analysis would also help Greggs judge whether a location is financially realistic. A shop near a busy railway station, retail park or high street may have higher rent, but it may also attract more customers throughout the day. Greggs has also developed extra sales channels such as delivery, Click + Collect and its customer app. These can help increase sales from the same shop, making it easier to reach break-even and then move into profit.

Contribution per unit = £20 − £12 = £8
Break-even output = £8,000 ÷ £8 = 1,000 units
Margin of safety = 1,200 − 1,000 = 200 units
The business is currently producing 200 units above break-even, meaning sales could fall by 200 units before a loss is made.

MODEL ANSWER

A business has fixed costs of £8,000 per month, a selling price of £20 per unit and variable costs of £12 per unit. Calculate the break-even output and the margin of safety if current output is 1,200 units. [4 marks]

EXAM PRACTICE QUESTION

Advantages

Simple to understand and calculate
Helps with planning and forecasting.
Useful for product and pricing decisions
Show the impact of cost changes
Helpful for start-ups and new products.

Disdvantages

Assumes all output is sold (unrealistic assumption)
Assumes costs behave in a linear way.
Ignores changes in demand and competition.
Does not consider qualitative factors.
May give a false sense of security.

Confusing break-even with profit: Students sometimes say a business is making a profit at break-even. At break-even, total revenue equals total costs, so the business is making neither a profit nor a loss.

Forgetting fixed costs: Some students only focus on variable costs and revenue. Break-even depends on covering all costs, including fixed costs such as rent, salaries and insurance.

Mixing up contribution and profit: Contribution per unit is not the same as profit per unit. Contribution shows how much each sale contributes towards fixed costs after variable costs have been covered.

Assuming break-even guarantees success: Break-even analysis is useful, but it is based on estimates. Sales, costs and prices may change, so students should not treat the break-even point as certain.

ANALYSIS

COMMON ERRORS

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