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Break-even analysis gives businesses a goal, one that they can achieve and say they are making a profit now. It is an important metric that helps evaluate business performance in terms of units sold or revenue.
What is Breakeven Analysis (Links to an external site.)?
Breakeven (in Units) = Fixed Costs ÷ (Selling Price – Variable Costs)
From the above formula, we can understand that
- Lower fixed cost will lead to reaching breakeven point sooner. For example- various companies decrease fixed costs in situations like an economic downturn by lowering like reducing salaries, downsizing/layoffs, etc.
2. Decreasing variable cost (the cost incurred to produce each unit)- These costs are recurring in nature and increase proportionally to increasing production. Reducing the costs of raw material, packaging, or transporting costs can reduce the variable costs.
3. Increasing the selling price is also an option to reach a breakeven point sooner. Still, it will not work in sales are low due to consumer sentiments about the product, low purchasing power due to the economic downturn, etc.
Applications:
- Gives a clear picture of revenue and profit
For any business, it is imperative to know its target profit and breakeven revenue. Breakeven dollar is the amount that companies make, after which every dollar is their profit.
Breakeven (Revenue) = Total Breakeven (in Units) * Selling price per unit
- Operational Efficiency
Analysis of contribution margin and breakeven point gives the information on a company’s operational efficiency. It also informs the decision-makers to buy or make parts, materials for the production.
Breakeven Point (in Units) = Fixed Cost ÷ Contribution Margin Per Unit
- Adverse situation
In a situation like an economic downturn, mismanagement of resources, and lack of incentive among salespeople, it is crucial for businesses to know how to reach target profit by tweaking selling price or fixed cost.
Break-even analysis is an important tool for businesses to understand where they are and where they want to go, but it should be periodical and methodical.
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