Fixed vs variable costs: the split that drives your pricing and your break even

Ask ten owners of SMEs and startups for their break even point: two or three answer with a precise figure. The rest know last year’s profit, but not the level of revenue below which every month burns cash. The cause is almost always the same: the line between fixed and variable costs was never drawn seriously. Yet that line drives three major decisions, your selling price, your break even threshold, and the amount of risk you carry when activity slows down.

The definitions that actually help

A variable cost moves with activity: sell twice as much and it roughly doubles. A fixed cost stays put whether you sell or not, at least over the decision horizon, usually twelve months. Forget which account the cost sits in. What matters is behavior: what happens to that invoice if revenue drops 20% next quarter?

• Typically variable: raw materials, goods for resale, sales commissions, shipping on orders, payment fees, contractors billed per project.
• Typically fixed: rent, insurance, software subscriptions, recurring professional fees, depreciation, and above all permanent payroll, which often represents 60 to 70% of the fixed costs of a services SME.
• The decisive test: picture a quarter with sales down 20%. The invoices that shrink on their own are variable; everything else is fixed, whatever the spreadsheet says.

Why the split drives pricing and break even

Contribution is an amount: revenue less variable costs. The contribution margin rate divides that amount by revenue; multiply by 100 to express it as a percentage. Break even revenue is fixed costs divided by that rate as a decimal. Direct costs are not automatically variable: the cost of assigned staff can remain fixed in the short term. Gross margin therefore does not necessarily use the same cost base.

A selling price is never debated in the abstract. It is debated against the contribution margin, because that margin pays the fixed costs, and nothing else does.

A full worked example

Take an SME at €2M of revenue. Variable costs: €1.2M, or 60% of sales. Contribution is therefore €800,000, giving a contribution margin rate of 40%. Fixed costs: €600,000. Operating profit: €200,000. The break even point takes one line: €600,000 divided by 40% equals €1.5M of revenue. The company has a safety cushion of €500,000, or 25% of its sales: activity can fall by a quarter before it starts losing money.

Now look at what that structure says about pricing. A large customer asks for a 10% discount. On a typical sale at 100, the variable cost is 60 and the margin is 40. At 90, the margin falls to 30: a 10% discount cuts the margin by 25%. To rebuild the €800,000 of contribution that covers fixed costs and profit, volume would have to rise by 33%. In other words, a 10% discount only pays off if it triggers a third more sales, which is rarely realistic. I have watched discounts like that get granted in a five minute phone call, with no calculation at all. Three lines would have justified saying no.

The semi variable traps

In practice, few costs are purely fixed or purely variable. The typical case I see with clients looks like this: an inherited spreadsheet classifies the entire payroll as variable because the sales team earns commissions, and the break even that comes out is wrong by several hundred thousand euros. Semi variable costs, partly fixed and partly volume driven, are the number one source of error in these calculations.

• Payroll: commissions are variable, but base salaries are not. A permanent team is a fixed cost over a six to twelve month horizon, whatever label the spreadsheet applies.
• Step fixed costs: a lease, a machine or a production role is fixed until capacity saturates, then jumps a full step. A break even computed without those steps goes wrong the moment growth forces the next one.
• Energy and logistics: part subscription, part volume indexed. Split the invoice; do not classify it whole on one side.
• Per seat software licenses: they climb with headcount and almost never come down by themselves. Variable on the way up, fixed on the way down.
• Optimistic labeling: calling a cost variable does not make it variable. What counts is the real speed at which you can cut it if activity falls.

Cost structure and risk in a downturn

Compare two companies at €2M of revenue and €200,000 of profit. Company A carries €600,000 of fixed costs and 60% variable costs. Company B outsources little: €1M of fixed costs and 40% variable costs. Same sales, same profit. A 20% drop in revenue splits them brutally: A still earns €40,000, B loses €40,000. The mechanism works both ways: in growth, B converts each additional euro of sales into 60 cents of margin against 40 for A. That is operating leverage: the higher the share of fixed costs, the more profit amplifies swings in activity, upward and downward alike.

So there is no good structure in the abstract. A fast growing startup can afford high leverage; an SME in a cyclical market is often better off making part of its costs variable, even at a slightly higher unit price, to lower its break even and buy resilience. The trade off should be made with eyes open, with both scenarios quantified side by side.

• Recompute your break even twice a year, and at every structural change (a hire, new premises, a large contract).
• Express it as monthly revenue: an annual threshold triggers no decision, a monthly one compares directly to the order book.
• Split semi variable costs rather than classifying them whole: a well built 80% approximation beats an exhaustive but wrong classification.
• Before any discount or price cut, compute the extra volume needed to recover the same margin in euros. The number alone often ends the discussion.

The split between fixed and variable costs fits on one page and can be built in a few days from a trial balance. It is one of the first exercises we run with owners of SMEs and startups, because it illuminates three topics that seemed unrelated: pricing policy, the safety threshold, and how the model holds up when activity stalls. If your current break even is an estimate rather than a number, that is the right starting point for a diagnostic.

Reduce expenses without damaging profitable delivery

Record each expense, contractual date, notice period and effect on delivery if reduced. A fixed cost is not necessarily impossible to change, but it does not disappear when sales fall. Compare savings that remove useful capacity against the revenue and contribution lost.

Separate immediate reductions, renewal negotiations and essential costs. Track realised cash savings and operational consequences rather than a theoretical cut target.

See how to prepare this decision.

Frequently asked questions

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