Split the costs first
Everything depends on classifying each cost as fixed or variable, and the classification has to reflect how the cost actually behaves rather than which ledger it sits in.
| Typically fixed | Typically variable |
|---|---|
| Rent and lease | Raw material |
| Permanent salaries | Direct wages on piece rate |
| Insurance | Packing material |
| Depreciation | Power consumed in production |
| Interest on term loan | Freight outward |
The computation
- Contribution = sales less variable cost
- Contribution ratio = contribution ÷ sales
- Break-even sales = fixed cost ÷ contribution ratio
- Break-even as % of capacity = break-even sales ÷ projected sales at full capacity
- Margin of safety = projected sales less break-even sales, as a percentage of projected sales
How a credit officer reads it
A break-even point at 45% of capacity means the unit stays profitable even if it achieves under half of what it projects. That is comfortable. A break-even at 85% means almost everything has to go right, and the officer will read the rest of the file with that in mind — particularly the revenue assumptions.
Two frequent mistakes
- Treating all salaries as fixed in a unit that pays production staff on piece rate.
- Leaving depreciation out of fixed cost, which flatters the break-even point.