Breakeven analysis is a best financial tool for any business looking to determine its financial viability and profitability. It is a simple yet powerful tool that helps businesses calculate the minimum amount of revenue they need to generate to cover their costs and make a maximum profit.
In this blog, I will provide you with a comprehensive guide to break-even analysis, including its definition, formula and examples, Uses also it’s Advantages and Disadvantages. Whether you’re a business owner, an investor, or just curious about the world of finance, this blog will equip you with the knowledge you need to understand and apply breakeven analysis in your business decisions. So let’s dive in this article.
What is Breakeven Analysis?
A break-even analysis is a financial calculation that weighs the cost of a new business, service or product against the unit sell price to determine the point at which you will break even.
Breakeven reveals the point at which you will sold enough units to cover all of your costs. At that point you will have neither loss or have a made profit.
Breakeven Chart
What is Marginal Cost ?
Marginal cost is the change in total production that comes from making or producing one additional unit. To calculate marginal cost, divide the change in production costs by the change in quantity.
To purpose to marginal cost is determine at what point an organization can achieve economies of scale to optimize production and overall operations.
If the marginal cost of producing one additional unit is lower than the per-unit price price, the producer has the potential to gain a profit.
Break-even point
The point at which marginal cost equals to average total cost is known as the break even point.
Break-even point calculate as
Total fixed costs / Contribution per unit
Here is Contribution per unit = Selling price per unit – Variable price per unit
Margin of Safety is the point at which a firm’s actual sales are greater than it’s breakeven point.
Total Costs = Fixed Costs + Variable Costs
Here is Fixed Costs are costs that do not change as output changes. For example Rent
Variable costs depend on the amount a business produces for example the more burgers McDonald’s sells, the more parties and burger buns it will need.
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Breakeven Analysis Example and Calculation
A pizzeria does a break-even analysis to determine how many pizzas they have to sell to break even on the investment.
Fixed costs are Rs 9,00,000 and the food cost is 50%. Unit price to be Rs 120.
So the our formula of calculating the breakeven point is
Total fixed costs / Contribution per unit
Rs 900,000 / (Rs 120 — Rs 60) = 15,000
Pizzas must be sold to break even.
Breakeven sales will be 15,000 x 120 = Rs.18,00,000.
Advantages of Breakeven Analysis
- Breakeven analysis helps businesses make decisions about pricing strategy, costs and the level of sales.
- It provides a basis for pricing of products & setting revenue targets.
- Breakeven analysis helps assess the impact of price & cost changes
- It also helps mitigate risks by avoiding unprofitable investments or product lines.
- It is a useful planning tool and thus a part of any business plan.
Limitations of Breakeven Analysis
Breakeven is only a forecast. It can change
- If the price of raw materials or number of competitors change.
- If the current market is volatile, breakeven becomes less predictable
To summarise, it does not predict demand, depends on reliable data and ignores competition.
Uses of Breakeven analysis
Pricing decisions
Help businesses to determine the minimum price they need to charge for their products or services to cover their costs and make a profit.
Cost control
It can help businesses identify their fixed and variable costs, and determine where they can cut costs to improve their profitability.
Business planning
Breakeven analysis can help businesses develop realistic sales targets and determine the level of sales they need to achieve to break even or make a profit.
Capital expenditure decisions
Breakeven analysis determine the minimum amount of revenue they need to generate to justify investments in new equipment, technology, or other capital expenditures.
Sensitivity analysis
Breakeven analysis can also help to businesses evaluate the impact of changes in key variables, such as sales volume or cost per unit, on their profitability.
Conclusion
Breakeven analysis can be a valuable tool for businesses of all sizes to make informed financial decisions and improve their bottom line.