Break-even analysis is a financial tool which helps the company to determine after which stage they will be profitable. Break-even point is where the company neither make money nor losses money, but covers all the cost incurred.
Breakeven is useful in studying the relationship between cost and revenue. The point at which total cost and total revenue are equal. After that, the no gain no loss situation, though opportunity costs have been paid and capital has received the risk-adjusted, expected return.
Components of breakeven analysis
Fixed costs
The fixed costs occurs after taking the decision to start an economic activity and these costs are directly related to the level of production, not the quantity of production. Fixed costs include interest, taxes, salaries, rent, depreciation costs, labour costs, energy costs etc. The costs are fixed in nature.
Variable costs
Variable costs are directly proportional to the quantity of production. The costs will increase or decrease in direct relation to the production volume. These costs include cost of raw material, packaging cost, fuel and other costs that are directly related to the production.
Formula
Break even quantity = Fixed costs / (Sales price per unit – Variable cost per unit)
Where:
- Fixed costs are costs that do not change with varying output (e.g., salary, rent, building machinery).
- Sales price per unit is the selling price (unit selling price) per unit
Benefits of Break-even analysis
- Catch missing expenses: In a new business, it happens that few expenses are missed. With the help of break-even analysis, to reach break even point all the financial commitments are reviewed.
- Set revenue targets: The break-even analysis is complete, the company knows how much to sell to be profitable. Similarly, this will help to set more concrete sales goals.
- Make smarter decisions: however break even analysis helps in making good decision based on the facts to become successful.
- Better Pricing: Finding the break-even point will help in pricing the products better. therefore, this tool is helps in providing the best price of a product that can lead to maximum profit without increasing the existing price.
- Cover fixed costs: Likewise, Doing a break-even analysis helps in covering all fixed cost incurred.
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