What is a break-even analysis?
Break-even analysis is the process of determining an organization's break-even point. It requires considering fixed cost, variable cost, price per unit, and number of units. Break-even analysis helps when:
You want to identify the number of units you need to sell to reach the break-even point
You know the number of items you need to sell, but want to decide on the right price for your product
What is a fixed cost?
Fixed costs are costs that are incurred by an organization for producing or selling an item and do not depend on the level of production or the number of units sold. Some common examples of fixed costs include rent, insurance premiums, and salaries. You can see that all of these costs do not change even if you increase production or make more sales in a particular month.
What is a variable cost?
Variable costs are the costs that are directly related to the level of production or number of units sold in the market. Variable costs are calculated on a per-unit basis, so if you produce or sell more units, the variable cost will increase. Some common examples of variable costs are commissions on sales, delivery charges, and temporary labor wages.
How can the break-even point help your business?
The break-even point is a great metric and an important tool that helps your business in a lot of ways. Here are the top three benefits of the break-even point in running your business:
It's important to study the feasibility of any project or new product line that you're planning to launch. With break-even analysis, you can identify the time and price at which your business will turn profitable. This helps you plan the range of activities you need to reach that point, set up a turnaround time for your tasks, and stick to a timeline.
Fluctuations in business are a common scenario. External circumstances, like trade agreements and changes in the political climate, have an impact on your sales. This may cause your variable or fixed costs to surge. In such cases, break-even analysis will help you to decide on new prices for your products. The break-even point gives you a clear picture of how much time will it take for your business to recover any losses and break even again after a change in the business forecast.
Strategy making is an integral part of any organization. Whether you're trying to promote your brand-new product, stay ahead of your competitors, or cut down on your expenses, you need to have a strategy in place. Break-even analysis helps you to formulate these strategies. If you have a break-even point tool, you can try out changes to variables like the cost involved in the promotions or the rate of depreciation, and calculate how many units you need to sell to reach the break-even point. This helps you craft a more formidable strategy and reap better benefits for your company.