Break-even is the point at which a business is not making a profit or a loss.

Businesses calculate
their break-even point and are able to plot this information on a break-even graph.
Break-even is the point at which revenue and total costs are the same, meaning the business is
making neither a profit nor a loss. The break-even level of output informs a business of how
many products it needs to sell to reach the break-even point (BEP).

Break-even is calculated as follows:

Break-even = fixed costs ÷ (selling price − variable costs)

The result of this calculation is always how many products a business needs to sell in order to
break even. The calculation in brackets must be completed first.

Example

A business that sells T-shirts wants to find out what its BEP is.

Its fixed costs are £400.

The selling price (per unit) is £10.

The variable costs (per unit) are £6.

Therefore:

Break-even = £400 ÷ (£10 − £6)

= £400 ÷ £4

= 100

So this business breaks even when it sells 100 T-shirts.

Sometimes the result is a little more complex, as the BEP may not be a whole number (eg
100.12). In such cases, the business would always need to sell an additional item in order to
break even. An example of this is shown below:

Break-even = £401 ÷ (£10 − £6)

= £401 ÷ £4

= 100.25 T-shirts

In this case, the business would need to sell 101 T-shirts to break even
 The break-even graph

A break-even graph shows a break-even point (BEP) visually. A break-even graph shows the
revenue, costs, number of products sold and BEP. An example is below:

The graph above demonstrates a break-even point (BEP) of 100 units.

Creating a break-even graph

Assume a firm has the following costs:

 fixed costs: £400

 selling price: £10 per unit
 variable costs: £6 per unit
To calculate the variable cost, multiply variable cost per unit by number of units. In this example,
assume that the variable cost per unit is £6 and there are 200 units, so the variable cost is £1,200.
Construct a chart with output (units) on the horizontal (X) axis, and costs and revenue on the
vertical (Y) axis. Onto this, plot a horizontal fixed costs line - it is horizontal because fixed costs
don’t change with output.

Then plot a line to represent variable cost starting at the same point as the fixed costs line.
Because the variable costs line is drawn above the fixed costs line, it becomes the total costs
line. This is because the fixed cost added to the variable cost gives the total cost.

Now plot the revenue line. To do this, multiply sales price by number of units sold (output).

If the sales price is £10 and 200 items are planned to be sold, the calculation is:

£10 × 200 = £2,000 total revenue

Where the revenue line crosses the total cost line is the break-even point -costs and revenue
are the same. Everything shown below this point is loss, and everything above it is profit .
1.

Margin of safety

The margin of safety is the amount sales can fall before the break-even point (BEP) is reached
and the business makes no profit. This calculation also tells a business how many sales it has
made over its BEP.

The margin of safety is calculated as follows:

Margin of safety = actual sales − break-even sales

For example, a business has a BEP of 100 products and has made 150 sales. Therefore:

Margin of safety = 150 – 100

= 50 products

This means the business is making profit on 50 of its items sold, and its sales could fall by 50
items before the BEP were reached.
A company can use its margin of safety to see whether a product is worth selling or not. For
example, if the BEP is 3,800 items and projected sales are 4,000 items, the business may decide
not to sell the product as it would only be making profit on 200 items, making it high risk.

The below example demonstrates a BEP of 100. With sales at 200, this represents a margin of
safety of 100 units (ie 200 − 100).

Changes in revenue and costs

Changes in revenue

An increase in revenue is always a positive thing for a business, because if revenue increases
then profits are also likely to increase. Increasing revenue also allows a business to get past
its break-even point (BEP) and increase its margin of safety by selling more products. However,
this only applies if costs stay the same or decrease. If costs increase, the increase in revenue
may have no impact.

A decrease in revenue is bad for a business. If revenue is decreasing, a business is at risk of not
breaking even or having very low margins of safety and levels of profit. The only scenario where
a decrease in revenue is not damaging to a business is when costs are also decreasing. If costs
are also decreasing, the business may be in the same overall financial position. Sometimes, if
revenue decreases, a business may try to reduce its costs, for example by sourcing cheaper
materials or employing fewer staff.

Changes in costs
Increasing costs usually have a negative impact on a business. They are likely to increase the
BEP or reduce the business’ profit. With increasing costs, a business would have to sell more
products in order to break even or make a profit. When costs increase, businesses often have to
make the choice of absorbing increased costs or passing them on to customers by increasing
prices. As a result, the business will be more likely to make a loss.

Decreasing costs are a positive thing for a business, as long as the quality of its product or
service remains the same. Decreased costs are likely to lower the BEP and give a business
access to more profit, as it will need to sell fewer products to break even. A business may
decide to keep the savings as profit or pass them on to customers as a price decrease. If
customers are aware that the business’ costs have decreased (eg if electricity bills are reduced
by 50% for everyone in the UK), they may expect a price decrease to be passed on to them.

Profit and loss

Profit

Profit is represented on a break-even graph as anything above the break-even point (BEP).

Profit is displayed as the shaded area between the revenue and total cost lines. The bigger this
area is on a break-even graph, the more profit the business is making. In the below example,
the area of profit is relatively small. This is because the BEP is relatively high. If the BEP were
reduced, the area of profit would increase.

Loss

Loss is represented on a break-even graph as anything below the break-even point. Loss is

displayed as the shaded area between the revenue and total cost lines, below the BEP. On the
below example, the area of loss is large, representing a high level of sales required to break
even.