How to calculate your break-even point

business.gov.au defines the break-even point as the level where income and expenses come out equal. Sell less than that and the business makes a loss; sales beyond it start producing a profit.

You can state it as a number of units, a sales figure or hours of billable work, for a month or a year. The method is the same each way: work out what each sale leaves after the costs that come with it, then how many sales it takes to cover the costs that don't.

Start from your profit and loss statement for a recent period, which lists your sales and expenses, and go through it line by line. Put each cost in one group or the other:

• Fixed costs stay much the same whatever you sell in the period. business.gov.au's budget guide gives insurance, rent and car leases as examples.
• Variable costs move with the amount you sell or make. business.gov.au defines a variable cost as one that rises and falls with how much you produce or how much customers want. The cost of the stock you sell, materials, packaging and sales commissions usually behave this way.

Some costs sit across both. A delivery van may have a lease payment that stays the same each month and fuel that rises with the number of deliveries, so split the cost between the groups. Wages depend on how staff are paid: hours rostered up and down with sales behave like a variable cost, while a set salary behaves like a fixed one. business.gov.au's budget guide lists wages among variable costs, so decide by how your own business works.

Contribution is what a sale leaves after its own variable costs. For a single product, it is the selling price less the variable cost of one unit. That amount goes towards fixed costs first, and once they are covered, it becomes profit. For this calculation, contribution must be positive. A zero or negative contribution cannot cover positive fixed costs.

Use the price customers actually pay after any regular discounts, because a discount comes straight off the contribution. Use the variable costs that genuinely come with each sale, such as the goods themselves, packaging and postage.

Divide fixed costs for the period by the positive contribution per unit. The result is the number of units needed to cover fixed costs. If units can only be sold whole, round up to the next whole unit so the sales cover all fixed costs.

Every unit sold beyond the break-even point adds its contribution to profit, and every unit short of it leaves part of the fixed costs uncovered.

A business that sells more than one thing, or sells its time, can work in sales value instead, using figures from the profit and loss statement. Sales and total contribution must both be positive for this calculation:

1. Add up the variable costs for the period.
2. Take them away from sales to find the total contribution.
3. Divide the total contribution by sales. This gives the share of each sale left after variable costs, as a decimal.
4. Divide fixed costs by that share. The result is the sales figure at which the business breaks even.

This method assumes the mix of products stays about the same. If you start selling more of a line with a small contribution, the share left after variable costs falls and the break-even point rises.

A service business that bills by the hour can do the same sum per hour: divide fixed costs by the hourly rate less any variable cost per hour, to find the billable hours needed.

Set the break-even figure against actual sales from your profit and loss statement. The amount by which sales exceed break-even, sometimes called the margin of safety, is how far sales could fall before the business makes a loss. If sales sit close to break-even, a quiet month or a rise in costs can tip the result into a loss.

Monthly figures matter in a seasonal business. Fixed costs keep coming in quiet months, so some months can fall below break-even while the year as a whole covers its costs. business.gov.au suggests drawing on your profit and loss statement when you set sales targets and prices.

Because the sum is simple, it is easy to ask what would happen if something changed. Change one input at a time and recalculate:

• A price rise increases the contribution from each sale, so fewer sales are needed to break even.
• A discount does the opposite. business.gov.au points out that discounts affect your bottom line and suggests checking they still let you cover your costs.
• A new fixed cost, such as a larger lease or an extra salary, raises the break-even point.
• Higher supplier prices raise variable costs and shrink the contribution from every sale.

To find the sales needed for a target profit rather than for breaking even, add the target profit to fixed costs before you divide.

business.gov.au suggests looking at your prices again at least once a year, and sooner when costs or the market shift. If you need help setting them, it points to your accountant or a business adviser. It also lists costs going up while profits don't as a sign of poor profitability.

Break-even is a planning estimate. It assumes prices and variable costs per unit hold steady, that every cost fits neatly into fixed or variable, and that the sales mix stays the same. Recalculate when any of these change.

It also measures profit, not cash. Customers who pay on credit, stock bought ahead of sales and loan repayments all move money at different times from the profit and loss statement. A cash flow forecast, which business.gov.au describes as an estimate of your future sales and costs, shows whether there is enough cash each month while you work towards break-even.