Break Even Analysis: Why Does It Have to Look So Complicated?

You’re ready to turn your passion into a business – so off you go to the bank and BAM!

You and your brilliant idea are faced with intense questions about your sales projections, variable costs, fixed costs, contribution margin, profit…breakeven? You’re feeling overwhelmed – but stop. Give me 15 minutes and by the end of this post you’ll be rambling on about breakeven with the best of them.

And as a bonus, I’m not wasting your time because learning breakeven isn’t just about getting the loan—it’s about setting yourself up for success.

At first glance the breakeven chart is frightening:

Here's a blog I wrote to support small business owners

Do it really need to be this complicated? Let's break it down.

It’s daunting to see all the intersecting lines and the words of ‘margin of safety’, ‘fixed cost’, ‘maximum profit at full capacity,’ blah blah blah.

Pizza Anyone

To really understand breakeven I think it is important we use a real world example. Let’s use a business that sells products to customers – we’ll open an imaginary pizza shop.  Breakeven for a service business is a bit different and maybe an article for another day. 

Start with What We Know

Breakeven is basically how many units you need to sell in order to pay the bills. What is the point in your sales journey where all your expenses are covered but you have not made extra money?

To know this, you will need to know the following things:

• Fixed costs

• Variable costs

• Sales price

• Profit

• Contribution margin

In the next couple of paragraphs, we will determine each one for our Pizza Shop. Keep in mind, this is a simplified example and not meant to be a blueprint for a real pizza shop.

Fixed Costs are Fixed

Fixed costs are costs that are fixed – simple right? This means that every month you will have certain bills that you need to pay. It doesn’t matter if you sell one single pizza – you still must pay the bill. For example: rent. The rent is a fixed amount every month and your property owner won’t change the amount based on how many pizzas you sell. Rent is a fixed cost. What else is fixed? Insurance? Internet?

Now, of course, rent and other expenses can go up, but these expenses do not change based on the number of pizzas sold, so we consider them fixed. Some fixed costs could even change because you decide to change them – for example, your advertising budget or your own salary.

You may have noticed I use the words ‘expenses’ and ‘costs’ and ‘bills’ interchangeably – that is they all refer to payments a business owner needs to make.

Let’s make a list of our monthly fixed costs and we will put in some estimated costs for the purpose of our example*:

Fixed Expenses for our Pizza Shop
Expense	Estimated Cost
	Rent	$3,500
	Electricity	$1,100
	Advertising	$500
	Insurance	$1,000
	Telephone	$200
	Internet	$100
	Salaries	$8,500
	Loan Interest	$1,000
	Total Fixed Expenses	$16,000
*Note there will be other costs, this is for example only

What about the Chairs and Tables

Here’s a side note we should talk about: start-up costs. You will have costs that you incur as you set up your business. You’ll need to buy tables, chairs, an oven, and so much more. But you’ll be paying these expenses BEFORE you start the business, so we aren’t going to count those in our monthly expenses – but guess what we do need to calculate in? That loan you’re trying to get will have interest every month. We’ve added ‘loan interest’ to our expense list.

That will give us enough fixed costs to get our example running. Sure, there are more in the real world, but this is about understanding the idea so let’s move on and look at another set of costs. This next set of costs are not fixed. They are variable costs.

Variable Costs Vary

Variable costs vary – simple right?  For these, the monthly cost will vary (change) depending on how many pizzas you make each month. An easy example to help explain this is the cost of flour used in the business for the month. You can imagine that if you sell 500 pizzas you will use less flour than if you sell 2,000 pizzas. We can’t say with certainty that we will use 500 cups of flour – we need to know how many pizzas we sold in order to know our flour cost.

Cost of One Pizza

What does it cost to make one pizza? Now, I’m no pizza chef, and I am going to oversimplify the list and underestimate the costs, so before you get excited about the potential money to be made in the pizza business you better price your ingredients in the real world.

Ingredients to make one pizza:
Expense	Estimated Cost
	Dough (flour, yeast, oil)	$0.50
	Sauce (tomato base, seasonings)	$0.50
	Toppings (Pepperoni, veggies)	$1.50
	Cheese (mozzarella, parmesan)	$1.00
	Box, napkins, receipts, etc.	$0.50
	Total Cost of Pizza Ingredients	$4.00
*Note there may be other costs, this is for example only

Can you think of any other expenses that we haven’t included yet or we haven’t thought of? Try making a list now.

Salary: Fixed or Variable

I bet you’re wondering about salaries. Well, technically, if the pizza shop is open – you will have to pay the staff – even if you don’t sell any pizzas. On the other hand, if you are selling lots of pizzas, you may need to have more staff.

In that way, salaries do vary with sales volume. However, most businesses have a core staff (fixed cost) and then add part-time or seasonal employees as needed (variable cost). For our example, we’re going to keep it simple and say salaries are fixed costs. This works well for our example but note that it could be different in other operations.

More Than One Product

Yes, it’s true, pizza shops sell more than pizza. But hey, this is an intro article so we’re not going to be selling multiple products. Let’s pretend we have a walk up window selling pizzas only and we will save the multiple product chat for the next article. For a teaser, let me say, if we have pasta, drinks, and desserts, we will need to calculate a ‘weighted average’. But that’s for another day.

Pricing

Now we’re going to talk about sales price. In this article, we’re not going to talk about how we set the price of a pizza – that is a great discussion for yet another article. We really have so much to talk about!

Many business owners struggle with what to charge for their products, and for good reason. There’s often a psychological component (like imposter syndrome) that makes us unsure how to value our offerings appropriately. Charge more? Less?

While I could dive into various pricing strategies—cost-plus, markup percentages, competitive pricing, or value-based approaches (I know, it’s just more jargon)— we need a working number to plug into our formula.

For our pizza shop example, let’s simply set our price at $20 per pizza. And we’re not dealing with tax either.

Putting It All Together

Now to recap we have:

• Fixed costs: $16,000 per month

• Variable costs: $4 per pizza

• Sales price: $20 per pizza

  
  

Where’s the Money

You’re thinking about making money, getting rich, rolling in dough (pun intended) … you’re thinking about profit. In general terms, profit is the amount of money made from operating a business after accounting for all the expenses. You make a profit when your sales are higher than your costs. The opposite of profit is loss. You make a loss when your costs are more than your sales. Spoiler alert: when you make neither profit nor loss, you are at breakeven.

Breakeven in Three Steps

Step 1: Contribution Margin

The first step is to calculate the Contribution Margin. There is a simple formula to calculate contribution margin.

Formula: Sales price – variable costs = contribution margin.

For our example, we take our sales price (sale price of one pizza $20) and subtract the variable costs (price to make one pizza $4). The contribution margin is $20 – $4 = $16.

Contribution Margin for our Pizza Shop

Sales Price – Variable Costs = Contribution Margin

$20 – $4 = $16

This means that for every $20 pizza we sell, $4 covers the cost of the ingredients and packaging. This leaves $16 dollars left over (contribution margin). This $16 will now be used to cover the fixed costs of the business. This $16 (contribution margin) will CONTRIBUTE to paying the fixed expenses (including rent, salaries, insurance, etc.). Get it? Contribution margins contribute!

Now with that in mind, we move to Step 2.

Step 2: Covering the Fixed Costs

We know that we have a contribution from every pizza sold to help pay our fixed costs. Now we need to know how many pizzas we need to sell in a month to cover all the fixed costs. So how many times do we need to earn $16 to pay for the $16,000 in fixed costs? Makes sense, right?

Here’s a way to look at contribution margin

$16 + $16 + $16 + $16 + $16 …… + $16 = $16,000

How many times will we need to add  $16 to cover the $16,000 in costs?

Again, there is a formula: fixed costs / contribution margin

$16000 / $16 = 1,000 pizzas.

We now know that to cover all our to fixed expenses we need to sell 1,000 pizzas.

Let’s break that down:

• 1,000 pizzas at $20 = Sales of $20,000

• Costs to make the pizzas: 1,000 times $4 per pizza = $4,000 in variable costs

• Fixed costs are $16,000.

  
  

Let’s test it:

Sales – Fixed Costs – Variable Costs = Profit

So, $20,000 – $4,000 – $16,000 = 0

And this ZERO is the profit or loss. As mentioned above, a profit or loss of ZERO is the same as saying breakeven. All sales dollars earned paid for all our expenses incurred. No profit. No loss. Breakeven.

Breakeven in Dollars

We can also express our breakeven in dollars: 1,000 pizzas × $20 = $20,000 in monthly sales.

The breakeven point can be expressed as 1,000 pizzas sold or as $20,000 in sales dollars.

Understanding That Complicated Chart

Now let’s take what we know back to that complicated chart from the beginning of our note and let’s build our own chart.

It's getting clearer!

We will start with the x and y axis:

• x-Axis: Quantity in units (number of pizzas sold)

• y-Axis: This is the sales amount in dollars (pizzas sold * $20)

  
  

Now let’s have a look at the three lines on the graph:

The first one we see is a straight line titled Fixed Costs (FC). This is simply the list of fixed costs we have already calculated ($16,000). It does not matter how many pizzas we sell, this is the fixed cost, so it is a straight line.

The second line is Total Revenue (TR): This line starts at the bottom (where sales = $0 and quantity sold = 0). And every time the quantity increases by one, the sales value increases by $20 (price of a pizza). So it shows a steady increase to the right. At any point, you can look at a quantity sold and see how much revenue that sales quantity would generate. When we sell 100 pizzas, the revenue would be (100 20) or $2,000. When we sell 1000 pizzas the revenue will be (1,000 20) or $20,000. When we sell 1,500 pizzas the revenue will be ($1,500*30) or $30,000.

The third line, Total Cost (TC) is where it might seem a little tricky – we didn’t calculate total cost. The formula for Total Cost (TC) is Fixed cost + Variable Cost. We can calculate the total cost when we sell no pizzas to be $16,000. This is because there will be no variable costs if there are no pizzas sold. It is simply the value for fixed costs (because remember we have to pay the fixed cost even if we sell no pizzas). So that is why the line starts at $16,000 and it does not start at $0.  This is key so reread this paragraph to make sure you understand this idea.

Now, every time we increase our pizza sales, we add in the costs of making the pizza. Not so complicated anymore! If we sell 100 pizzas, our total costs are ($16,000 + (100 $4)) or $16,400.  If we sell 1,000 pizzas, our total costs are ($16,000 + (1000 $4) = $20,000. If we sell 1,500 pizzas, our total costs are ($16,000 + (1500 * $4) = $22,000.

Now that we have all the data in the chart, our lines are mapped. Let’s put them all together in the chart and analyze the data.

The key point in this chart is where the two lines intersect or meet. They meet at the point that sales revenue (Total Revenue) and costs (Total Costs) are the same number in dollars and units. Let’s break that down. Basically, there is a point (where the lines meet) that sales revenue and total expenses are the SAME! That point is breakeven – breakeven point – get it?

And if you look to the left of that – the red shaded area on this chart. Any pizza sales up to this point will not be high enough to cover all the costs. There will be a loss. For example, at 100 pizzas sold the total revenue is $2,000 but the total costs are still ($16,000 + (100 * 4) = 16,400). If you only sell 100 pizzas you will lose money ($2,000 – $16,400 = -$14,400).

Now, let’s look at the right side where things are better! For every pizza you sell over the break even point of 1,000, you will make a profit. If you sell 1,100 pizzas, you will make $20 1,100 = $22,000. You will have expenses of ($16,000 + (1,100 4) = $20,400) so you will have a profit of $22,000 – $20,400 = $1,600.

Maximum Capacity

Now let’s take a minute to look at the ending line of our chart ‘maximum profit at full capacity’. What does this mean? Well – in the real world there are limits. You are a small pizza shop – and your oven can only cook a certain number of pizzas per day. There is a limit.

What if we got an order for a huge event that is coming to town for the month of September? What if we got an order for 5,000 pizzas that month? Can we cook that many pizzas? No, because we figured out that the most we can cook is 2,000 per month. Our maximum capacity then is 2,000. To cook more than that, we would need to buy another pizza oven – or need to hire more staff – or rent a bigger shop and that would impact our costs. We would have more fixed costs. Maybe we would actually have lower variable costs, because we would be buying in bulk, so it’s not all bad but our calculations would have to be redone.

There is a point in every business that you’re at what we call maximum capacity that no matter how many customers you have – you can only serve so many in the time allocated. That’s what we call maximum capacity.

There are things you can do to adjust to the market, but the reality is based on the way you operate today, the resources that you have, there is a maximum production that you can have and the value of the sales at that point is maximum profit at full capacity.

Just a quick note, there are businesses where the maximum capacity could be quite large – like selling an ebook or a music download where maximum capacity is only limited by bandwidth or number of potential users – but the purpose of this example was to show you a business that produces pizzas so let’s not debate this today.

Ok, now let’s start to put it together again….

Margin of Safety

The final topic on the chart is Margin of Safety. Now that we know our breakeven sales is 1,000 pizzas also stated as $20,000 in sales, our maximum full capacity output is 2,000 pizzas (2,000 * 20 = $40,000). We have a margin of safety from 1,000 up to 2,000 pizzas. We could also say we have a margin of safety from $20,000 in sales to $40,000 in sales. If we sell anywhere in that range for the month, we know we are making a profit. It is our safe space. If we sell less than that, we are losing money.

Practical Application

Well, we did it, we know our chart and all the values on it! We can say that our pizza shop will break even at 1,000 pizzas a month. We have a metric that we can track each month to know if we’re on target without combing through our financial statements.

This is a metric that you can keep in your head as you are going through your day-to-day business – a guideline.

Busy is Not a Metric

Here is where I want to say you need to know your metrics. You want to be able to have these benchmarks in your mind that enable you every day to have a sense of where you are in your business. You do not want to be just running a business and thinking you’re doing well because you’re busy. Busy is NOT a metric.

You know your breakeven point and you know if you are reaching it.

What if all of a sudden, your property owner decides to increase your rent? Or if the price of flour skyrockets? Or if your competitor starts a price war? No problem – you just go back to your breakeven analysis. Change the numbers that need to change. Are fixed expenses more? Does your sales price change? It is ok – you got this. Put the new figures in and calculate the new breakeven. Maybe now you will need to sell 1,200 pizzas to breakeven.

You are equipped to quickly respond to anything that changes in the factors or the inputs.

Quick Recap

At its heart, break even is simply the number of units you need to sell in each period of time to cover all the expenses. It is the point where your sales equals your expenses. There is no profit or loss.

Now, this discussion was meant to simplify the basic concept of breakeven – we know the real world is not quite so simple, there will be multiple product lines, inventory, seasonal peaks, competition, price fluctuations, tax implications, cash flow and credit issues, product spoilage and more to factor in.

Once you understand the basic concept of breakeven you can start to add in details and personalize it to your business. And don’t fear that this might get complex or scary – there are several free online calculators and templates are available to help you visualize and calculate your unique breakeven point without complex math.

And never forget, it is your business – know your numbers and don’t get caught up in the jargon.

This is a blog I wrote for CEED. It, along with other great resources for entrepreneurs can be found here: TheHubNS

AMAZING FOLLOW UP

An amazing thing happened after I wrote the blog: a reader commented that he found it helpful and went ahead a built a CALCULATOR based on the article.

Check out Bruno's calculator: "Great article! Very easy to follow and understand. I have created a simple and easy to use calculator inspired by what I learned from it. The calculator can be found at the following url and uses the Pizza shop numbers as an example:

https://btalanski.github.io/break-even-calculator/ "