BREAK EVEN ANALYSIS

Break Even Analysis

Break Even Analysis

Breakeven Analysis

A mathematical method for analyzing the relationships among a firm's fixed costs, profits, and variable costs. Financial analysts are particularly interested in how changes in output and sales will translate into changes in earnings.

An analysis of a product or company's sales required to neither lose money nor make a profit, but simply to cover costs. A company needs to at least break even in order to make the expense of producing a product worth the effort. As a result, breakeven analysis is an important feature in evaluating the risk of an activity. Breakeven analysis calculates the relationship between the fixed costs, variable costs, and profit of the product (Warren :Reeve :& Duchac :2008 :12).

Break-even analysis is an expected component of most business plans, especially for startup companies. This calculator helps determine your company's break-even point, the amount of revenue you need to generate to cover your fixed and variable costs.

Discussion

The break-even analysis is not our favorite analysis because:

It is frequently mistaken for the payback period, the time it takes to recover an investment. There are variations on break-even that make some people think we have it wrong. The one we do use is the most common, the most universally accepted, but not the only one possible. (Siegel & Shim :2006 :141) 

It depends on the concept of fixed costs, a hard idea to swallow. Technically, a break-even analysis defines fixed costs as those costs that would continue even if you went broke. Instead, you may want to use your regular running fixed costs, including payroll and normal expenses. This will give you a better insight on financial realities. We call that “burn rate” these post-Internet days.

It depends on averaging your per-unit variable cost and per-unit revenue over the whole business.

Key Assumptions

The Break-even Analysis depends on three key assumptions:

Average per-unit sales price (per-unit revenue):

This is the price that you receive per unit of sales. Take into account sales discounts and special offers. Get this number from your Sales Forecast. For non-unit based businesses, make the per-unit revenue £1 and enter your costs as a percent of a dollar. The most common questions about this input relate to averaging many different products into a single estimate. The analysis requires a single number, and if you build your Sales Forecast first, then you will have this number. You are not alone in this, the vast majority of businesses sell more than one item, and have to average for their Break-even Analysis (Mott :2005 :148).

Average per-unit cost:

This is the incremental cost, or variable cost, of each unit of sales. If you buy goods for resale, this is what you paid, on average, for the goods you sell. If you sell a service, this is what it costs you, per dollar of revenue or unit of service delivered, to deliver that service. If you are using the basic Sales Forecast table for retail, service and distribution businesses, use a percentage estimate, ...