Question

In financial management, what is the importance of completing a breakeven analysis? How does a breakeven analysis help organizations budget in the short and long term? How does the breakeven analysis connect revenues and expenses for specific initiatives?

Answer 1

Breaveven ponint is the defined in two ways

1. The payback period i.e. the no of years or montgs after which the investmne tmade sby the company is recovred

2. Every company incurs a particular fundingf cost for making its investments in a project. Th minimum rate of return required to ensure that the funding cost is recovered by the company is called breavken rate of return. So, for example

cost of debt= 10% for a company

cost of equity= 15%

if the rate of return that a project can generate is 14%, then the company needs to decide what best mix of funding it can use to generate a positive cashflow

Lets calculate that now

out of total funding requirement debt required is X, equity required would be 1-x

so X * 10% +(1-X)*15%= 14%

solving above we get X=0.2, 1-X= 0.8

therefor the breakeven for a company iun terms of funding mix is debt 20%, equity 80%. If it intends to take more debt, it would be fine, but funding the project with more than 805 of equity would result in losses.

There fore the funding mix of debt:equity 20:80 is the breakeven

In the long run it helps to decide how a slight change in funding mix of the reate of retun would help improve the return on investment