Importance of Break Even Analysis
Complementary guide for the Break Even Analysis Template.
The analysis conducted by a business to determine the number of units which need to be sold for a specified price in order for the business to cover total cost associated with the production. The analysis identifies the break even point, the point at which the business is neither making loss nor profit. At break even point revenues are equal to zero, total revenue received are equal to total cost associated with the sale of products.
The break even analysis has different application in the business. In planning stage, the analysis is used in sales projection to determine how many units will have to be sold for the company to cover the cost associated with the production. Sales above break even point will results into profits. The analysis can be used by financiers to access the viability of business by accessing the units required to be sold before turning the venture into profitable business. Break even point can also be used by investors to determine the selling price of an investment at price which will not result into loss due to the sale of investments.
Break even point is calculated as Fixed Cost dividend by Contribution per Unit and contribution per Unit is computed as Selling Price minus Variable Cost. The calculation gives the number of sales in units to cover fixed cost and the variable cost before the business becomes profitable. Hence sales occurring above break even point will results into profit equal to contribution margin if the variable cost do not change and the business is producing within it production capacity. Productions beyond the business capacity in some instances require change in fixed cost and variable cost because more resources are required to produce the extra capacity. Changes beyond production capacity will call for analysis of breakeven point to determine whether it is preferable to stay within production capacity or increase production to meet the increased demand. The decision should be based on profit contribution resulting into increase in production. If increased capacity does not increase profit contribution, then the business should reconsider the decision on whether to increase the capacity.
Fixed costs are defined as cost which the business has to meet whether it produces or not, examples of such costs include leaseholds and management salary. Variable costs are cost tied to production and they are incurred as a result of goods or services production. Labor cost and material cost are examples of variable costs.
Excel is an excellent tool for analysis break even point. By keying in input, a business is supplied with decision tool to analysis different scenarios and determines the price and production units to be produced and sold to break even. Because a business can not easily control fixed cost, managers and business owners are always advised to manage variable cost in order to stay competitive in pricing. The excel template allows altering different variable to show break even units under different scenarios.