Question

what Break-even analysis means, and why it is important to a business.

                                                                       

Answer 1

“Break-Even Analysis is that technique which shows how to identify the level of output and sales of volume at which the firm 'breaks even', which revenues being sufficient to cover all its costs",

A break-even analysis is a useful tool for determining at what point your company, or a new product or service, will be profitable. It’s a financial calculation used to determine the number of products or services you need to sell to at least cover your costs. When you’ve broken even, you are neither losing money nor making money, but all your costs have been covered.

A break-even analysis results in neither a profit nor a loss. Instead, it determines the number of sales needed to cover all variable and fixed costs. It calculates the minimum number of units to sell and the sales volume needed to pay all expenses before making a profit.

For example, a break-even analysis could help you determine how many cell phone cases you need to sell to cover your warehousing costs . Anything you sell beyond your break-even point will add profit.

Benefits of Break-even analysis

Better Pricing: Finding the break-even point will help in pricing the products better. This tool is highly used for providing the best price of a product that can fetch maximum profit without increasing the existing price.

Cover fixed costs: Doing a break-even analysis helps in covering all fixed cost.

Catch missing expenses : When you’re thinking about a new business, it’s very much possible that you may forget about a few expenses. Therefore, a break-even analysis can help you to review all financial commitments to figure out your break-even point. This analysis certainly restricts the number of surprises down the road or atleast prepares a company for them.

Set revenue targets: Once the break-even analysis is complete, you will get to know how much you need to sell to be profitable. This will help you and your sales team to set more concrete sales goals.

Make smarter decisions: Entrepreneurs often take decisions in relation to their business based on emotion. Emotion is important i.e. how you feel, though it’s not enough. In order to be a successful entrepreneur, decisions should be based on facts.

Fund your business: This analysis is a key component in any business plan. It’s generally a requirement if you want outsiders to fund your business. In order to fund your business, you have to prove that your plan is viable. Furthermore, if the analysis looks good, you will be comfortable enough to take the burden of various ways of financing.

Calculation of Volume of Sales to Attain Target Profit: Break-Even analysis is used to know the volume of sales necessary to achieve a given profit.

Margin of Safety : The margin of Safety represents the difference between the sales at breakeven point and the total actual sales i.e Margin of Safety = Actual Sales- Break Even Sales It is the limit to which the sales may fall yet the firm may have no fear of loss

Change in Production Capacity: Break Even analysis helps the firm in taking the decision whether to increase or reduce its existing production capacity. In this respect, several factors are taken into account, such as, possibility of change in profit; possibility of change in quantity for sale or sales price, etc. If any change has positive impact on contribution of the firm the change will accepted or vice versa.

Effect of Alternative Prices: The positions of profit at different price- levels under given conditions of demand and costs can be shown with the help of Break Even Chart.

Decision Regarding Adding of New Products or Dropping of Old Ones: Break-Even Analysis enables a firm to arrive at a final decision whether to introduce any new product or not. It also helps a firm to decide whether to continue the production of the existing goods or to discontinue it by comparing the contributions in both the cases. Alternative having more contribution may be preferred. In case company wants to drop one of its products, break even analysis makes it easy to the firms to take this decision. Product with lowest contribution should be dropped and firm should concentrate on profitable ones.

Choosing Promotion Mix: In order to promote the sales of its product, a firm may take resort to different kinds of incentives; e.g., advertisement, prizes, after-sales-service, salesmanship, etc, in different proportions. The firms can find out from break-even analysis as to which of the promotion-mix they should choose so as to get maximum profit. The promotion mix that gives the maximum contribution may be adopted.