Break even analysis is helpful when a new businessman wishes to start a business, start-up or a new loan. As a result, the financial managers are required to prepare a report on the break even analysis to ensure the profitability of a firm during a certain time period.
The analysis of the break even point consists of the total costs, fixed costs, variable costs and the price of the unit products or the services. For example, this accounting analysis provides the managers and the owner of a firm with the useful tools to make informed and impactful decisions to earn profits by modifying their expenses and the price of the products.
In this blog, we will discuss what break even analysis is and why is it useful for your business. Moreover, we will discuss how to calculate the break even point and which variables are required for it. So, let’s start our discussion!
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What is a Break Even Analysis?
Break even analysis helps in pinpointing a point where the total costs and the income are equal to each other. At this point, a company can decide on how much cost they should reduce or how much the price should increase to accelerate the revenues.
This analysis is inevitable for those seeking a bank loan to expand their business. On the other hand, if a company is going to launch a new product, they need to estimate this point to analyse how much they need to sell the products at the current price to cover their total cost.
Besides, a small-scale business or a start-up is also required to estimate and calculate the break-even analysis to ensure they make key decisions regarding the costs and price of their product and services to start earning the projected earnings and to win a seed investment.
How to Calculate the Break Even Analysis?
Calculating a break even point does not require the services of a professional or a qualified accountant, an average person afraid of numbers can also do it with simple maths. However, they must ensure they have included all the expenditures in the fixed and variable costs.
Following is the formula for finding a break-even point:
Break-Even Point = Fixed Cost/(Revenue Per Unit – Variable Cost Per Unit)
Or
Break-Even Point = Fixed Cost/Contribution Margin
Where
Contribution Margin = Price of a product – Variable Cost
Fixed costs are a type of total costs which a firm has to incur, no matter if the product is being produced or not. For example, the rent, depreciation cost and utility bills etc. On the other hand, variable costs are the costs associated with the production of goods and services. For example, the cost of raw materials, managerial costs and transportation costs etc. The total cost is the combination of fixed cost and variable cost.
Example of a Break-Even Analysis
Following is an example of a break-even analysis
| Fixed Cost | Variable Cost Per Unit | Price Per Unit Sold |
| £ 200 000 | £6 | £10 |
Break-Even Point = Fixed Cost/(Revenue Per Unit – Variable Cost Per Unit)
= 200 000/(10-6)
= 200 000/4
= 50 000 units
It means the Company needs to sell 50 000 units to earn a profit. After crossing a sale of 50 000, the company will be able to earn higher profits above the total cost. At a sale of 50 000 units, the company’s revenue and total costs are equal and it is earning zero profit. Below this level, the costs are higher than the revenues.
Benefits of Conducting a Break Even Analysis
The identification of a break even point helps in a number of ways. Most importantly, the analysis helps in the decision making process regarding the prices, costs and revenue from sales. Moreover, it helps in targeting the sales and revenues for achieving a particular level of profit. Let’s discuss the benefits of calculating this figure!
Price Decisions
An effective price can increase the probability of higher profit margins. So, this analysis helps in setting a price that will benefit your business in the long run and your business can survive in a competitive environment where you can set a competitive price.
Cost Decisions
This analysis also helps identify the costs associated with the production of the products. It identifies if your business needs to cut the fixed costs or the variable costs. You can reduce the total costs either by reducing the fixed or variable costs.
Target Sales
Above all, this analysis helps in setting up a target for sales of the products. For example, you can observe how much sales a company needs to earn a profit, as discussed in the above example. It prepares a roadmap, that a company will follow to engage in the most efficient production and selling activities.
Identify Business Risks
At this point, your business managers if a business plan is viable or not. You can stop following that plan instantly and prepare another plan that will benefit and help your business grow, increasing revenues and profits ultimately.
Conclusion
In sum, the start-ups or established businesses seeking to launch a new product or a loan need a break even analysis to take the crucial decisions. It helps in the provision of different tools of costs and prices to reach the desired profit.
On the other hand, it provides an analysis of unit cost and price and how much it needs to be changed to rise above the break even point where the total costs are equal to the total revenue. To increase the revenue, the costs can be reduced or the price of the products can be increased. It is totally at the disposal of the managers which decision works best for their company by this break even analysis.
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Disclaimer: All the information provided in this article on Break-Even Analysis is general in nature and it does not intend to disregard any of the professional advice.
