Two calculations underpin most good commercial decisions, and a surprising number of business owners have never done either. They take an afternoon, they use figures you already have, and they change how discounting, hiring and capacity decisions look.
Fixed and variable costs
Start by splitting costs into those that change with volume and those that do not.
Variable costs move with each unit sold — materials, freight on sales, direct labour where it genuinely flexes, merchant fees, commissions.
Fixed costs continue regardless within a range — rent, insurance, permanent salaries, subscriptions, most administration.
Many costs are semi-variable and need splitting. Power has a base load and a usage component. Salaried staff are fixed until volume forces another hire, at which point they step up rather than sliding.
Perfect precision is not required. Approximately right is enough to make better decisions than no analysis at all.
Contribution margin
Contribution margin = selling price − variable cost.
It is what each sale contributes toward fixed costs and, once those are covered, toward profit. As a percentage: contribution margin divided by selling price.
This is the number that should drive pricing and discounting decisions, and gross margin is often used as a rough proxy for it.
Break-even
Break-even in units = fixed costs ÷ contribution margin per unit.
Break-even in revenue = fixed costs ÷ contribution margin percentage.
That is the point at which you cover everything and make nothing. Knowing it tells you how much of your month is spent working to stand still, which is frequently a sobering figure.
The related number is the margin of safety — how far current sales sit above break-even. A business trading 8 percent above break-even has almost no tolerance for a downturn.
Why this changes how discounting looks
This is where the arithmetic surprises people.
Take a product selling at $100 with variable cost of $60. Contribution is $40, or 40 percent.
Discount it by 10 percent. The price becomes $90, variable cost is unchanged at $60, and contribution falls to $30 — a 25 percent reduction in contribution from a 10 percent price cut.
To generate the same total contribution you now need to sell 33 percent more units. A 10 percent discount requiring a third more volume to stand still is a very different proposition from how discounting usually feels.
The reverse also holds. A 10 percent price increase on the same product lifts contribution from $40 to $50, meaning you could lose 20 percent of your volume and be no worse off.
Run this calculation before any discounting decision. It is the single most useful piece of arithmetic in small business.
Applying it to real decisions
Should we take this low-margin job? If you have spare capacity and it contributes anything above variable cost, it helps cover fixed costs. If it displaces higher-contribution work, it costs you. Capacity is the deciding factor, not the margin in isolation.
Should we hire? A new employee raises fixed costs and therefore break-even. Calculate the additional revenue required at your contribution margin, and ask whether that volume is realistically available.
Which products should we push? Rank by contribution margin per unit of the constrained resource — per labour hour, per square metre of shelf, per machine hour — rather than by margin percentage alone. The highest-percentage product is not the best one if it is slow to produce.
Can we absorb a cost increase? A supplier price rise reduces contribution directly. Work out the price increase needed to hold contribution, then decide whether the market will bear it.
Where it needs care
Fixed costs are only fixed within a range. Doubling volume usually means more space, more people and more equipment, and break-even steps up rather than staying flat.
Businesses with many products need either a weighted average contribution margin or analysis by product group. A blended figure across products with very different margins can mislead if sales mix shifts.
Doing it once a year
Costs move. Recalculate annually, and after any significant change — a new lease, a hire, a supplier price change.
Most owners who do this for the first time find their break-even is higher and their margin of safety thinner than they assumed. That is uncomfortable and useful.
business.govt.nz publishes break-even calculators and guidance free.
General information only, not financial advice.
