Break-even analysis answers one of the most practical questions in business: how many do we need to sell before we stop losing money? It’s a simple calculation, but it tells us a lot about whether a price makes sense.
Once we know the break-even point, we can go one step further and ask how many we need to sell to make a certain profit. That’s target profit pricing, and it uses the same numbers.
Let’s work through both with one example. Imagine Leah has just opened a food truck that sells burritos. She has a small budget and wants to know whether her prices will actually keep the business going.
Fixed Costs and Variable Costs
Before we can find a break-even point, we need to split Leah’s costs into two groups.
Fixed costs stay the same no matter how many burritos she sells in a month. For Leah, these are the truck lease, her permits, insurance and her phone and card-machine fees. Let’s say they add up to $6,000 a month.
Variable costs go up with every burrito she sells. These are the tortilla, fillings, sauce, foil wrap and the paper bag. Let’s say they come to $4 per burrito.
Why does this split matter? Because the fixed costs have to be paid even in a slow month. If Leah sells nothing, she still owes $6,000. Each burrito she sells helps chip away at that amount.
Contribution Margin: What Each Sale Adds
Leah sells her burritos for $10 each. Each one costs her $4 in ingredients and packaging, so each sale leaves $6 over.
That $6 is called the unit contribution margin. It’s the amount each sale contributes toward paying the fixed costs, and once those are covered, toward profit.
Unit contribution = Price – Variable cost per unit
For Leah, that’s $10 – $4 = $6.
We can also show it as a percentage of the price. $6 out of $10 is 60%, which is the contribution margin ratio. So 60 cents of every sales dollar goes toward fixed costs and profit.
How to Calculate the Break-Even Point
Break-Even Volume (Units)
The break-even point is where total revenue equals total costs. Leah makes no profit and no loss. To find it in units, we divide the fixed costs by the unit contribution:
Break-even volume = Fixed costs / Unit contribution
For Leah: $6,000 / $6 = 1,000 burritos a month.
Is 1,000 a lot? If the truck trades 25 days a month, that’s 40 burritos a day. That gives Leah something real to think about. Can she sell 40 a day at her current spot, or does she need a busier location?
Break-Even Sales (Dollars)
Sometimes we want the answer in dollars rather than units, especially for a business selling lots of different items. There are two ways to get there:
- Multiply the break-even volume by the price: 1,000 x $10 = $10,000
- Divide the fixed costs by the contribution margin ratio: $6,000 / 0.60 = $10,000
Both give the same answer. Leah needs $10,000 in sales each month just to break even.
Let’s Check It
It’s always a good idea to check a break-even answer. At 1,000 burritos, Leah takes in $10,000. Her costs are $6,000 fixed plus 1,000 x $4 = $4,000 variable, so $10,000 in total. Revenue equals costs, so profit is zero. That’s the break-even point.
Drawing a Break-Even Chart
A break-even chart shows the same idea as a picture. Units sold go along the horizontal axis and dollars go up the vertical axis. We draw three lines:
- Fixed costs: a flat line at $6,000, because it doesn’t change with volume
- Total costs: starts at $6,000 when no burritos are sold, then rises by $4 for every burrito
- Total revenue: starts at zero and rises by $10 for every burrito
Here are the numbers we would plot for Leah:
| Burritos sold | Total revenue | Total costs | Profit or loss |
|---|---|---|---|
| 0 | $0 | $6,000 | -$6,000 |
| 500 | $5,000 | $8,000 | -$3,000 |
| 1,000 | $10,000 | $10,000 | $0 |
| 1,500 | $15,000 | $12,000 | $3,000 |
| 2,000 | $20,000 | $14,000 | $6,000 |
The point where the revenue line crosses the total cost line is the break-even point, at 1,000 burritos. To the left of it, the gap between the lines is a loss. To the right, it’s profit. And because the revenue line is steeper than the cost line, the profit grows with every extra burrito.
Adding a Target Profit
Breaking even keeps the truck on the road, but Leah also needs to earn a living. Let’s say she wants $3,000 profit a month.
We simply treat the target profit like another fixed cost that has to be covered:
Target volume = (Fixed costs + Target profit) / Unit contribution
For Leah: ($6,000 + $3,000) / $6 = 1,500 burritos a month.
That’s 60 a day over 25 trading days. Leah now knows the gap between surviving (40 a day) and hitting her goal (60 a day).
Working Out the Price for a Target Profit
We can also turn the question around. Suppose Leah thinks she can realistically sell 1,200 burritos a month. What price would she need to charge to make her $3,000?
Target price = Variable cost per unit + (Fixed costs + Target profit) / Expected volume
For Leah: $4 + ($6,000 + $3,000) / 1,200 = $4 + $7.50 = $11.50.
So at 1,200 burritos a month, she would need to charge $11.50 each. This is close to what textbooks call target return pricing, where a firm sets its price to reach a profit goal at the volume it expects to sell. It sits alongside cost-plus pricing, since both start from costs.
What Happens When the Price Changes?
This is where break-even analysis becomes useful for marketing decisions. Every price gives a different break-even point. Let’s say Leah tries out a few prices:
- At $8, contribution is $4, so break-even is 1,500 burritos
- At $10, contribution is $6, so break-even is 1,000 burritos
- At $12, contribution is $8, so break-even is 750 burritos
- At $14, contribution is $10, so break-even is 600 burritos
So should Leah just charge $14? Not so fast. A higher price lowers the break-even point, but it also means fewer people will buy. The break-even calculation doesn’t know that.
Imagine Leah watches her sales and estimates that she would sell about 1,400 burritos a month at $10, 1,100 at $12 and 700 at $14. Now we can work out the profit at each price:
- At $10: (1,400 x $6) – $6,000 = $2,400 profit
- At $12: (1,100 x $8) – $6,000 = $2,800 profit
- At $14: (700 x $10) – $6,000 = $1,000 profit
In this example, $12 works best. It isn’t the cheapest price, and it isn’t the one with the lowest break-even point. It’s the one that balances margin against demand. We cover the wider set of things that shape a price in internal factors influencing price.
Limits of Break-Even Analysis
Break-even analysis is a great starting point, but we need to know where it falls short:
- It ignores demand. It tells us how many we need to sell, not how many customers will actually buy at that price. That’s why Leah needed her own sales estimates.
- It assumes costs stay put. Fixed costs can jump if the business grows. If Leah adds a second truck, her fixed costs go up sharply.
- It assumes a steady cost per unit. In reality, Leah might get a bulk discount on tortillas, or face a price rise on avocados.
- It gets harder with many products. If Leah adds drinks and nachos, each with a different margin, the answer depends on the mix she sells.
Does that make it less useful? Not really. It just means we use it alongside customer research and judgment, rather than on its own.
Try It Yourself
Let’s say Leah’s ingredient costs rise to $5 a burrito and she keeps her price at $10. What’s her new break-even point?
Her contribution drops to $5, so break-even becomes $6,000 / $5 = 1,200 burritos a month. A $1 rise in ingredient costs means she needs to sell 200 more burritos just to stand still. What price would bring her break-even back to 1,000? She would need $6 contribution again, so $11.
If you can follow that, you can apply break-even analysis to almost any product, from a burrito to a phone plan.
Sources
Corporate Finance Institute: “Break-Even Analysis: How to Calculate the Break-Even Point”
