Break even is the level of sales at which contribution (sales less variable costs) exactly covers fixed costs, so the business makes neither a profit nor a loss. Break even units equal fixed costs divided by contribution per unit, and break even sales equal fixed costs divided by the contribution margin ratio. The margin of safety is how far budgeted or actual sales sit above that point, usually shown as a percentage.
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What is the break even point?
Every sale earns a contribution: the selling price less the costs that rise directly with that sale, such as materials, freelance labour, card fees or delivery. Contributions first pay for the fixed costs that do not change with volume in the short term, such as rent, salaried staff, insurance and software. Once fixed costs are covered, every further pound of contribution is profit. The break even point is where total contribution equals total fixed costs.
It is a management tool, not a figure in the statutory accounts. Its value lies in answering practical questions: how many sales are needed each month to cover the overheads, what a price cut does to the volume required, whether a new hire is affordable, and how much sales can fall before the business starts losing money.
How do you split costs into fixed and variable?
Go through the profit and loss account line by line and ask whether each cost would change if sales rose or fell by 10% next month.
- Variable: raw materials and goods for resale, subcontractors paid per job, sales commission, packaging, carriage, payment processing fees.
- Fixed: rent, business rates, salaried staff, insurance, accountancy, software subscriptions, loan interest, depreciation.
- Semi variable: costs with a fixed element plus a usage element, such as energy or phone contracts, should be split into the two parts.
- Stepped: costs fixed within a range but jumping at a threshold, such as a second van or another member of staff once volume passes a certain level.
FRS 102 uses a similar distinction when valuing stock. Paragraph 13.8 describes fixed production overheads as indirect costs that remain relatively constant regardless of the volume of production, and variable production overheads as those that vary directly, or nearly directly, with volume. The variable costs in a break even calculation usually overlap with, but are not identical to, cost of sales in the accounts, so do not simply lift the gross profit line.
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How do you calculate break even sales?
| Measure | Formula |
|---|---|
| Contribution per unit | Selling price less variable cost per unit |
| Contribution margin ratio | Contribution per unit divided by selling price (or total contribution divided by total sales) |
| Break even units | Fixed costs divided by contribution per unit |
| Break even sales value | Fixed costs divided by contribution margin ratio |
| Units for a target profit | (Fixed costs plus target profit) divided by contribution per unit |
| Margin of safety | Budgeted (or actual) sales less break even sales |
| Margin of safety percentage | Margin of safety divided by budgeted (or actual) sales |
For a VAT registered business, use prices and costs net of VAT. FRS 102 paragraph 29.20 requires turnover to exclude VAT, including VAT imputed under the flat rate scheme, and expenses to exclude recoverable VAT. A business that is not VAT registered, or that cannot recover input VAT, should include the irrecoverable VAT in its costs.
What does a worked example look like?
Illustration only. A small company makes and sells garden furniture kits.
- Selling price per kit, net of VAT: £50
- Variable cost per kit (timber, fixings, packaging, carriage): £30
- Fixed costs for the year (rent, salaries, insurance, depreciation, interest): £120,000
- Budgeted sales: 8,000 kits, or £400,000
- Contribution per kit is £50 less £30, which is £20.
- Contribution margin ratio is £20 divided by £50, which is 40%.
- Break even units are £120,000 divided by £20, which is 6,000 kits.
- Break even sales value is £120,000 divided by 40%, which is £300,000 (6,000 multiplied by £50 gives the same answer).
- Margin of safety is 8,000 less 6,000, which is 2,000 kits or £100,000.
- Margin of safety percentage is £100,000 divided by £400,000, which is 25%. Sales could fall by a quarter before the business makes a loss.
- Budgeted profit is the margin of safety multiplied by contribution: 2,000 multiplied by £20, which is £40,000 before tax.
Now test a decision. If the owner cuts the price to £45 to win volume, contribution falls to £15 and break even rises to 8,000 kits. The business would need its entire budgeted volume just to break even, so the price cut only makes sense if it brings in substantially more than 8,000 sales.
The figure above is before tax. If the company’s profits are within the £50,000 small profits limit and it has no associated companies, Corporation Tax at the small profits rate of 19% would leave £32,400. Above that limit the main rate of 25% and marginal relief come into play, so a target for profit after tax needs the right rate.
How does it work with several products or for a service business?
With several products, use a weighted average contribution margin ratio based on the expected sales mix. If 60% of sales earn a 40% margin and 40% of sales earn a 25% margin, the weighted ratio is 34%, and break even sales are fixed costs divided by 34%. The answer only holds while the mix holds: a shift towards lower margin work raises the break even point even if total sales are unchanged.
Service businesses often work in hours rather than units. Contribution per chargeable hour is the charge out rate less any directly variable cost, and break even is fixed costs divided by that figure. Comparing break even hours with realistic chargeable hours available, after holidays and non chargeable time, is a quick test of whether pricing and staffing are viable.
Why can break even differ from the profit in the accounts?
Break even analysis treats all fixed costs as costs of the period in which they arise. Statutory accounts under FRS 102 do not always do so. Paragraph 13.9 requires fixed production overheads to be allocated to stock on the basis of normal capacity, so part of this year’s factory overhead can sit in closing stock and be expensed next year when the stock is sold. Unallocated overheads are expensed in the period they arise. If stock levels change significantly, the profit in the accounts will not match a contribution based calculation for the same year. This is a timing difference, but it can mislead owners comparing the two; see stock valuation and gross, operating and net profit.
What about cash break even?
Profit break even is not the same as having enough cash. For cash break even, remove non cash costs such as depreciation from fixed costs and add cash commitments that are not in the profit and loss account, such as loan capital repayments, owners’ drawings or dividends and tax payments. In the example, if fixed costs include £10,000 of depreciation and the company repays £12,000 of loan capital a year, cash fixed costs are £122,000 and cash break even is 6,100 kits. Timing is the next question, which is what a cash flow forecast adds.
What mistakes come up most often?
- Using gross margin as contribution. Cost of sales may include fixed items and exclude variable ones such as commission and carriage.
- Forgetting the owner’s pay. In an owner managed company, if the director’s salary or the drawings needed to live on are not in fixed costs, break even is understated.
- Mixing VAT inclusive prices with VAT exclusive costs. This overstates contribution by the VAT element.
- Assuming straight lines. Volume discounts, overtime and stepped costs mean contribution and fixed costs change at different volumes.
- Calculating it once. Recalculate whenever prices, costs or the mix change, and track the margin of safety in the management accounts.
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Related Accountapedia entries
- Fixed, variable and semi variable costs
- Contribution margin explained
- Budget variance analysis
- Absorption vs marginal costing
- Gross margin vs markup
- Budgeting for small businesses
- What happens if you break the ISA rules
Sources
Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.