Question

What is break even analysis? What are its uses and benefits?

Answer 1

Break even analysis is the technique of determining that level of sales at which a company is able to recover all its costs and starts making a profit. In a break even analysis costs are differentiated into fixed costs and variable costs. Fixed costs are costs that do not change with the volume of production (examples are rental expenses, manager’s salary etc.) while variable costs are costs that change with the volume of production (examples are direct material, direct labor, energy costs etc). In a break even analysis total variable costs and fixed costs are compared with the sales revenue to determine that level of sales volume (or sales value) at which the company is neither making a profit or a loss. In other words at the breakeven point the amount of profit and the amount of loss is nil (i.e. total costs = total revenue). Beyond the breakeven point a company y starts making profits.

Breakeven analysis is highly useful in the decision making process of a business. Business managers make use of breakeven analysis to determine how much sales volume will be required to start making a profit. This helps business managers to develop a pricing strategy. The pricing strategy is an integral part of a company’s business plan and it the break even analysis that helps a company to develop its pricing strategy. Managers also use break even analysis to determine target profits, to determine impact of change in prices and costs on profitability and when making make or buy decisions.