Fixed costs ÷ contribution margin. The single most important number for any small business.
| Scenario | Price | Var cost | Break-even units | Δ vs current |
|---|
Break-even is the number of units (or dollars of revenue) at which total revenue exactly equals total cost. Below that number, the business loses money on every dollar that comes in. Above it, every additional unit's contribution margin drops to the bottom line as profit. The math hinges on one number — contribution margin — which is the difference between price and variable cost per unit. Each unit's contribution covers a slice of fixed costs first; once fixed costs are fully covered, contribution becomes profit.
Fixed costs — costs that don't change with sales volume (rent, salaries, software)Variable cost — cost that scales with each unit (materials, hourly labor, payment fees)CM ratio — Contribution margin ÷ Price. Determines operating leverage.| Cost type | Examples |
|---|---|
| Fixed (don't scale with sales) | Rent, salaried payroll, software subscriptions, insurance, equipment leases, accounting fees, basic utilities |
| Variable (scale with each unit) | Raw materials, hourly production labor, payment processing (Stripe 2.9% + $0.30), shipping, packaging, sales commissions, transaction taxes |
| Mixed | Utilities (fixed connection + variable usage), shipping (fixed minimum + variable weight), some marketing (retainer + commission) |
Mixed costs need to be decomposed into their fixed and variable parts. Categorization is short-run; over multi-year horizons, every cost is variable as you can renegotiate or relocate.
A 10% price increase typically reduces break-even by 12-18%. A 10% variable-cost reduction reduces break-even by 4-8%. A 10% fixed-cost reduction reduces break-even proportionally. The leverage stack: price > CM > fixed costs > volume. Founders often optimize the wrong variable.
Standard break-even tells you the survival threshold. Target-profit break-even = (Fixed + Target profit) ÷ Contribution margin. If you need $4,000/month profit at $27 CM with $8k fixed: ($8,000 + $4,000) ÷ $27 = 445 units. Many business plans hit zero-profit break-even and stall — having never modeled the actual target.
Margin of safety = (Actual sales − Break-even) ÷ Actual sales. Strong businesses operate at 30-50% MoS so moderate downturns don't trigger losses. Below 15% is a warning zone — small fluctuations push into red. New businesses often launch at 0% or negative MoS and target 30% within 12-24 months. If you've been at 10% MoS for years, the business is fragile.
Sources: Standard managerial accounting CVP framework (Garrison/Noreen "Managerial Accounting" textbook); Drucker "The Effective Executive" on operating leverage; CFA Curriculum Level I cost-volume-profit; SBA small business cost categorization guidelines; Stripe pricing for payment processing variable costs.
The sales volume at which total revenue exactly equals total cost — zero profit, zero loss. Below: business loses. Above: every additional unit's contribution becomes profit. Most important number for any small business because it converts "is this viable?" into a concrete unit count: "we need to sell 297 widgets/month."
Two outputs from the same math: Break-even units = Fixed costs ÷ Contribution margin per unit. Break-even revenue = Fixed costs ÷ Contribution margin ratio. Each unit's contribution covers a slice of fixed costs first; once covered, additional contribution is profit. $8,000 fixed / $45 price / $18 variable = $27 CM = 297 units = $13,335 revenue.
Fixed don't scale with sales: rent, salaried payroll, software, insurance, equipment leases. Variable scale with units: raw materials, hourly labor, payment processing (Stripe 2.9%+$0.30), shipping, sales commissions. Mixed have both (utilities, some shipping). Decompose mixed into parts. Categorization is short-run; long-run, every cost is variable.
Contribution margin = Price − Variable cost. Gross margin = (Revenue − COGS) ÷ Revenue. Similar but COGS in financial accounting sometimes includes fixed manufacturing overhead. CM is for management/break-even; gross margin is for financial reporting. CM ratios above 60% = strong unit economics (software/services); below 30% = thin-margin volume business.
(Actual sales − Break-even sales) ÷ Actual sales × 100%. Measures how much sales can drop before hitting break-even. Strong businesses operate at 30-50% MoS; below 15% is warning zone. New businesses launch at 0% or negative MoS and target 30% within 12-24 months. Persistent low MoS = fragile business.
Powerfully nonlinear. 11% price raise ($45 → $50) at same costs lifts CM 18% and reduces break-even by 16%. Pricing is the highest-leverage variable in unit economics. Flip side: 10% price cut typically requires 20-30% more volume to maintain absolute profit. Always model break-even shift in pricing tests.
Standard break-even = Fixed ÷ CM (zero profit). Target-profit = (Fixed + Target profit) ÷ CM. To earn $4,000/mo on top of break-even at $27 CM with $8k fixed: ($8,000 + $4,000) ÷ $27 = 445 units. Useful for actual planning — break-even alone is the survival threshold; target-profit is the goal.
For services with hourly billing, the unit is a billable hour, variable cost is contractor rate or marginal time. For SaaS, unit is a customer (or seat), variable cost is per-customer infrastructure + payment processing. SaaS CMs often 80-95% because marginal cost is low — but CAC/LTV become relevant unit metrics. SaaS-equivalent question: "how many MRR dollars cover fixed costs each month?"
Contribution margin ÷ Operating income. $60k CM ÷ $10k op income = 6× leverage — each 1% revenue change moves op income 6%. High-leverage businesses (SaaS, content, infra) have huge upside from small volume increases AND huge downside from declines. Low-leverage businesses (hourly services) more defensive but less scalable.
Quarterly minimum, monthly for early-stage. Recalculate when: rent or major vendor cost changes, new salaried hire, product pricing change, supplier cost change, new product line. Many small businesses set break-even once at startup and forget — then can't explain margin erosion years later. Build break-even into standard month-end review alongside cash and AR aging.