Although we don’t expect business owners to turn into accountants or finance experts, but at least, they should understand the Break-Even Point (BEP) amongst other things to be constantly successful, by enabling them to better manage their profit and cash.
What is the Break Even Point?
Break even as the name suggests, is a situation when the business is just able to generate sufficient income to meet its expense obligations, or where the business’ total
revenue is equal to its total expenses. Provided sales are profitable, if the business is
trading below the break even point, it will make a loss. On the other hand, if it is trading above the break-even point, it will make a profit. The bigger the gap between the break-even point and the actual sales, the bigger the profit.
Why is the Break Even Point important?
Break-even point analysis is the simplest way for a business to determine if what it charges for its products and services will cover what it costs to make those products or provide those services. The higher the fixed costs for the business, the higher the break even point will be, meaning the more offerings it needs to sell.
Break-even point analysis is also a good time for the business to assess their true
cost of doing business and their direct and indirect costs very well. Therefore, working on a break even analysis can help you learn these figures and gain better insight into the accuracy of your prices and how realistic your sales goals are.
If the amount of sales a company needs to break even is more than it can realistically
achieve in a year, then the business knows its products or services may not be priced well-or it needs to work to reduce costs.
Furthermore, you should know the total contribution each product and service make to the company’s overall profit. This step is important because it can help businesses determine products and services that aren’t actually profitable, and the company can decide if it needs to increase the price, reduce the cost of offering it, or possible discontinue it.
Where to start
You should start by assessing the company’s most commonly sold products and services. You also need to gather a lot of information, such as the total fixed cost of making each product, the variable costs for each product, the sales price of that product, and the net profit derived from selling it.
When is it useful to calculate the Break-Even level of sales?
• When a start-up is making its initial business planning, it can test various assumptions about costs, prices, and demand to assess the viability of the business.
• After a new business has started, the cost and selling price assumptions will have turned into some kind of reality. Calculating the break-even point again lets it check the likelihood of success.
• If an established business is struggling with low profitability or making losses, break-even point analysis helps to focus attention on contribution margins and fixed costs.
However, you can also monitor the break even point even if a business is doing well. It is a good financial discipline to stop costs getting out of control and to watch for margins reducing as selling prices are discounted to win extra business.
How to calculate the Break Even Point level of sales by volume
In order to calculate your company’s breakeven point, you can use the following formula:
Fixed Costs ÷ (Price - Variable Costs) = Breakeven Point in Units
In other words, the break-even point is equal to the total fixed costs divided by the difference between the unit price and variable costs. In this formula,
Fixed Costs are stated as a total of all the operating costs for the firm, whereas Price and
Variable Costs are stated as per unit costs—the price for each product unit sold. The denominator of the equation, price minus variable costs, is called the contribution margin. After unit variable costs are deducted from the price, whatever is left—the contribution margin—is available to pay the company’s fixed costs.
>> Quote of the week
“It’s almost always harder to raise capital than you thought it would be, and it always takes longer. So, plan for that.” – Richard Harroch, Venture Capitalist and Author.
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