Break-even analysis answers a simple question: how much must the business sell before it stops making a loss? It also shows how much a fall in sales the business can absorb, and what level of sales a target profit needs.
Key terms
- Contribution = Sales − Variable costs. It is the amount available to cover fixed costs and then to generate profit.
- P/V ratio (profit-volume ratio) = Contribution ÷ Sales. It is the share of each rupee of sales that contributes to fixed costs and profit.
- Break-even point (units) = Fixed costs ÷ Contribution per unit.
- Break-even sales (₹) = Fixed costs ÷ P/V ratio.
- Margin of safety = (Actual or expected sales − Break-even sales) ÷ Actual or expected sales.
Worked example
A unit makes a single product.
| Item | Amount |
|---|---|
| Selling price per unit | ₹500 |
| Variable cost per unit | ₹320 |
| Fixed costs for the year | ₹18,00,000 |
| Expected sales | 15,000 units |
- Contribution per unit = 500 − 320 = ₹180
- P/V ratio = 180 ÷ 500 = 36%
- Break-even point = 18,00,000 ÷ 180 = 10,000 units, or ₹50,00,000 of sales
- Profit at 15,000 units = 15,000 × 180 − 18,00,000 = ₹9,00,000
- Margin of safety = (15,000 − 10,000) ÷ 15,000 = 33.3%
To earn a profit of ₹15,00,000, the unit needs sales of (18,00,000 + 15,00,000) ÷ 36% = ₹91,66,667, or about 18,334 units.
Assumptions to keep in mind
- Costs can be split cleanly into fixed and variable.
- Selling price and variable cost per unit stay constant over the range considered.
- Fixed costs stay fixed; in practice they step up when capacity is added.
- For more than one product, the sales mix stays constant.
When these assumptions do not hold — for example, volume discounts or a second shift — the analysis should be done in segments.
Using the result
- A low margin of safety signals that a small fall in volume will cause losses.
- Comparing P/V ratios across products shows which products contribute most per rupee of sales. Where capacity is the constraint, compare contribution per unit of the limiting factor (for example per machine hour) instead.
The break-even calculator and contribution calculator apply these formulas.
Disclaimer. This article explains the law as understood on the review date shown above. It is general information, not advice on any particular case. Provisions may have changed since; refer to the official sources and obtain professional advice before acting. Full disclaimer.