Fixed Costs, Variable Costs and Break-Even

Not all costs behave the same way, and telling them apart is the key to one of the most useful numbers in business: the point where you stop losing money. Some costs sit there every month no matter what you sell — those are fixed costs. Others rise with every single unit you move — variable costs. Sort your costs into those two buckets and you can work out your break-even, the sales level where the money coming in finally covers the money going out. We’ll do exactly that for Foundry, the parts maker running through this course, and land on a number it can watch all year.

Fixed costs: the bills that don’t move

Fixed costs are the ones that stay the same whether you sell ten units or ten thousand. For Foundry we’ll treat its $3.0M of operating costs — the factory lease, salaried staff, insurance, admin and software — as fixed: they don’t flex with volume, at least not in the short run. (That’s a teaching assumption; in reality a few of those line items wobble a little.)

The comforting thing about fixed costs is that they’re predictable. The dangerous thing is that they don’t shrink when sales dip. A quiet month still owes the full $3.0M share of rent and salaries, which is exactly why a slow quarter hurts so much.

Variable costs: the ones that scale with each sale

Variable costs rise and fall directly with how much you sell. For Foundry these are its $6.0M of product costs — the steel and alloy in each part, plus the machining labor to make it. Every part shipped consumes another slug of those costs; sell nothing and they fall toward zero, sell double and they roughly double. At $10.0M of revenue, that $6.0M of variable cost is 60% of every sales dollar.

A quick way to spot a variable cost: ask “if I made one more part, would this cost go up?” The steel, the machining time, the packaging on an order — all yes, all variable. The factory lease — no, that’s fixed.

The share of each sales dollar left after variable cost has a name: contribution. Foundry keeps $10.0M − $6.0M = $4.0M, so its contribution-margin ratio is $4.0M ÷ $10.0M = 40% — the same as its gross margin. In plain terms, every dollar of revenue costs 60¢ to produce and contributes 40¢ toward covering fixed costs. (Per unit, the same idea is contribution per unit = price − variable cost per unit.) Once the fixed costs are fully covered, that 40¢ on the dollar becomes profit.

Break-even: where revenue finally covers costs

Break-even is the sales level where total revenue exactly equals total costs — you’re not losing money, but not yet making any. Per unit, the formula is beautifully simple:

break-even units = fixed costs ÷ contribution per unit

When you’re working with a whole company rather than a single product, the same logic runs on the contribution-margin ratio and gives you a break-even in revenue:

break-even revenue = fixed costs ÷ contribution-margin ratio

Worked example: Foundry’s break-even

Foundry carries $3.0M of fixed costs, and each sales dollar throws off 40¢ of contribution. So its break-even is $3.0M ÷ 0.40 = $7.5M of revenue. Check it: at $7.5M of sales, variable costs are 60% × $7.5M = $4.5M, leaving $3.0M of contribution — exactly enough to cover the $3.0M of fixed cost, for zero profit.

Foundry actually does $10.0M of revenue, comfortably $2.5M above its $7.5M break-even. That cushion is its margin of safety, and it’s where the profit comes from: every dollar of revenue past break-even drops 40¢ to the bottom line, so $2.5M × 40% = $1.0M of operating profit — which is exactly Foundry’s operating profit. The whole P&L reconciles from this one number.

Operating leverage: why fixed costs swing profit harder

Here’s the twist that makes this more than bookkeeping. A business with high fixed costs relative to variable ones has powerful operating leverage: once it clears break-even, extra sales convert to profit at the full contribution rate, but a sales dip bites hard because those fixed costs don’t budge. Foundry is a live example — because its $3.0M of fixed cost stays put, a 10% drop in sales ($10.0M → $9.0M) doesn’t trim profit by 10%; it knocks operating profit from $1.0M to about $0.6M, a 40% fall. A business that’s mostly variable costs would see a flatter, safer, smaller swing.

That’s why the mix of fixed and variable costs shapes how risky a company is. We’ll build on this in unit economics and contribution margin, and see the sharp end of it in cost-cutting and restructuring, where lowering fixed costs is often the whole point.

Rule of thumb: break-even revenue = fixed costs ÷ contribution-margin ratio (or, per unit, fixed costs ÷ contribution per unit). The bigger your fixed costs, the more sales you need before the first dollar of profit — and the harder profit swings once you get there.

Fixed or variable?

Read each cost and decide which kind it is. Tap a card to flip it and check your answer.

Sort the costs

Drag each item into the bucket it belongs to — or tap an item, then tap a bucket. Hit Check placement when you’re done.

How to use it

When someone frets about a slow month, the useful question is “where’s our break-even?” — because that turns anxiety into a specific target. For Foundry that target is $7.5M of revenue; drop below it and the business loses money. Useful phrases: “What’s the contribution margin on this?” “How much of our cost base is fixed versus variable?” “How much revenue do we need just to cover fixed costs?” “If sales drop 10%, how much does profit fall?” That last one gets at operating leverage: the more fixed your costs, the more violently profit reacts to a change in sales. Knowing your break-even and your cost mix lets you say, calmly and specifically, exactly how much room the business has.