5 Steps to Make a Break-Even Analysis Efficiently

What is a break-even point?

The break-even point (BEP) is when a business's revenues and expenses are equal, this signifies that the company is not earning a profit or losing money. In other words, the company has reached the point when its production costs equal its product revenues. When a company hits the break-even point, also known as the point of break-even, it stops operating at a loss.

Understanding break-even analysis

By understanding your break-even analysis, you can make decisions about pricing, production, and profits that will help you maximize your profits and make your business successful.

There are several fixed overhead costs associated with owning and operating a business, such as rent, salaries, taxes, and insurance. Add in the variable costs like supplies, materials, labor costs, research and development, and marketing, among others, to get the overall costs. On the other hand, total revenue describes the money a business makes from selling its products or services. The break-even point is important for businesses because it shows them how many sales they need to make to start making a profit.

Simply put, the BEP is the point at which sales proceeds to cover all costs. If you sell less, the business will suffer a loss, and if you sell more than that, the business's gross earnings will start to rise.

What is a break-even point example?

XYZ Enterprises manufactures tires with total fixed costs of SGD 30,000 and variable costs of SGD 20. The company set the sale price per unit for these tires at SGD 45.

In this case, 

Break-even point = 30,000/ (45-20) = 1200 units

So, based on the aforesaid break-even analysis, the BEP (break-even point) for Sigma is 1200. For XYZ to break even on these fixed and variable manufacturing expenses, at least 1200 units of the product must be sold.

Relationship between Break-even Point and Sales 

Since the break-even point is defined by total cost, revenues have no direct bearing on the break-even point. However, whether a business reaches its break-even point depends on sales revenues. A business experiences a loss if sales are below total costs and it does not reach the break-even threshold. When a business doesn't generate enough revenue to reach the break-even mark, debt builds up over time, ultimately leading to a business closing its doors.

Relationships between price, volume, fixed costs, and variable costs

The relationship between fixed costs, variable costs, price, and volume is complex. Still, it can be summarized in the following way: Fixed costs, such as rent and insurance, stay the same regardless of production volume or price. Variable costs, on the other hand, vary in accordance with production volume or pricing. Examples of variable expenses include labor, raw materials, and transportation. It is important to consider fixed and variable costs and pricing when calculating a company's overall profit or loss. For example, an increase in production expenses may be offset by higher prices if properly managed — leading to a higher profit margin despite an initial increase in expenditure from variable costs.

In order for a business to remain profitable and balance fixed costs, variable costs, price, and volume, it must have the right combination of all these elements. It is the job of the business owner or manager to keep an eye on these components and adjust accordingly.

How Does Cutting Costs Affect the Break-even Point?

When it comes to cutting costs, the break-even point is impacted. For example, the break-even point will decrease if a business reduces costs such as overhead expenses, materials costs, or wages and salaries. This means that the business will need to generate less revenue to reach profitability. Conversely, if a business increases costs, the break-even point will increase - requiring more sales to reach a profitable situation. Therefore, adjusting expenses affects when a company achieves its intended profit level.

Why is break-even analysis vital for business growth?

Break-even analysis is a data-driven way to gain insights into a business and reach the point of profitability faster. 

Break-even analysis assists businesses in determining how many units must be sold to avoid losses.

It optimizes production practices and directs resources appropriately, resulting in smarter decisions when assessing risk and determining which strategies should be employed by the business.

In the early stages of your business, break-even analysis can help you determine profitability and adjust pricing.

Entrepreneurs can plan inventory levels using break-even analysis to ensure that they have goods ready for sale for a predetermined time.

Break-Even Analysis: A Crucial Tool for Business Owners

Startup: A break-even analysis is crucial for a new business. It advises management on how to price their products realistically. Break-even analysis also reveals whether the new company is profitable according to its business plan.

Innovate and develop: Before beginning production of a new product, the business must focus on a break-even analysis to see whether the new investment will be a good decision for the business.

Business model modification: The break-even analysis applies if a business model changes, such as going from retail to wholesale. This analysis will assist the business in deciding whether or not to adjust a product's selling price.

Benefits of a break-even analysis

1. Break-even analysis helps businesses to identify and understand their fixed costs, variable costs, and break-even points. 

2. It can be used to make informed pricing, production levels, and other strategic decisions. 

3. It can help businesses to monitor their financial performance and track progress toward profitability.

4. To help determine the minimum level of sales or production the business needs to achieve to stay in business.

5. To aid businesses in setting prices for their products or services.

6. It can help you limit risk by avoiding unprofitable investments or product lines

A business has to do a break-even analysis because it determines whether the business can last in the long run. There are 5 easy steps to make a break-even analysis or break-even point calculation.

5 easy steps to make a break-even analysis

1. Determine Variable Unit Costs

There are two types of costs. First is the total variable costs. Total variable costs are costs that change proportionately with the changes in volume or capacity. The greater the capacity, the greater the total variable costs and vice versa.

The second type is the fixed costs. For example, the cost of using gasoline on a vehicle is calculated by mileage but the price of each liter of gasoline remains constant and is not affected by mileage.

As an illustration, the price of petalite is $8 per liter. 1 liter of petalite can cover a distance of 20 km. So what is the calculation of variable costs per unit? In this example, the cost of petalite per km is $8:20 = $0.4.

2. Determine Fixed Costs

Fixed costs can be more important than variable costs and these costs have two characters. The first character is that fixed costs do not change or are not influenced by a particular period or activity.‍

So the unit fixed cost is inversely proportional to the change in volume. If the volume is low, the unit fixed costs are high. On the contrary, at high volumes, the unit fixed costs are priced low.

For example, the carrying capacity of a passenger car is 50 passengers daily so it can carry 1500 people in a month. If you want to increase the number of passengers to more than 1500 people every month, you must increase the number of cars to transport passengers.

From the total number of passengers, we must calculate the depreciation cost to get the estimated cost per unit with the formula:

(Purchase price - Residual value): Estimated usage

($200,000 - $20,000): 10 years = $18,000.

In this example, fixed costs or annual depreciation costs are $18,000 or $1,500 per month. After the depreciation costs are obtained, the cost per unit of each passenger can be calculated using the formula:

Unit costs per month = Fixed costs per month: Number of passengers per month‍

3. Determine Unit Selling Price

Determining unit selling price is certainly very important for your business growth and profit. When you set a new selling price, you can then find out how to calculate your sales profit.

The way to calculate net profit per unit can be calculated after finding out the cost and the selling price per unit. Here are some of the important factors in determining selling prices:

I. Customers

A product is intended to attract the attention of customers and potential customers to buy the product. So, you have to make sure that the selling price of your product is indeed a price that can easily be accepted by the customers.

Do not set the price too high because it can be rejected by the customer and do not set it too low because it leads to losses.

II. Competitors

It is also necessary to look at the selling prices offered by competitors who have similar products. You must make sure that the selling price of your product can compete with the selling price of competing products. That means that you also need to pay attention to your level of profit.

If the predetermined level of profit causes the price to be too expensive, then it may be a good idea to apply the method of calculating product profit and loss by lowering the potential profit to get a price that is not too far away from the price offered by competitors.

III. Cost

This is the most important factor in determining the selling price of the product. Do not set the selling price lower than the costs because you will end up with a loss.

4. Determine sales volume and unit price

The break-even points will change as the sales volume and the unit price changes. Calculation of break-even points are as follows:

BEP = FC : (P-VC)

BEP: Break-even Point

FC: Fixed costs

P: Unit price

VC: Variable costs

From this break even point formula, we can observe that the break-even point is equal to the total fixed costs divided by the difference between the unit price and the variable costs. You also have to note that in this formula, fixed costs are expressed as the total of all overhead costs for the company.

‍While the price and variable costs are expressed as costs per unit or the amount for each unit of product that is sold.

5. Create a spreadsheet

To calculate break even point, you will make or use a spreadsheet then convert the spreadsheet into a graph. The spreadsheet will plot break-even for each level of sales and product prices.‍

The graph will also show you the break-even for each of the prices and expected sales volumes. Click here for free break-even analysis templates.

Psst... You may also be interested in: 7 Minutes Complete Guide to Business Cash Advance for Startups

Limitations of Break-even analysis

Break-even analysis is a popular and widely used tool for making business decisions. However, it is important to understand the limitations of this tool before making any decisions. 

Focuses only on fixed costs: Generally speaking, break-even analysis only considers fixed expenses. This implies that it does not account for any variable expenses, including those for labor or supplies. Because of this, it may be challenging to determine an organization's break-even point precisely.

Ignores risk : Break-even analysis ignores risk since it believes that the anticipated future cost and sales circumstances are known and fixed.

Price and profitability assumptions: Break-even analysis assumes that all products or services are sold at the same price. But in practice, costs might differ based on the good or service, the market, and other elements. The break-even analysis presupposes that all items or services are equally profitable. However, certain goods or services may be more profitable than others. Because of this, it may be challenging to anticipate profitability, sales, and revenue with accuracy

Strategies to lower your break-even point

Four strategies can assist you in lowering your break-even point. Increasing prices, reducing costs, boosting efficiency, and optimizing output are all ways to ensure you achieve your break-even point as quickly as possible by generating more revenue with the same expenses.

Increase Prices

One of the most common ways to lower your break-even point is to increase your prices. By charging more for your products or services, you will be able to earn more income while still maintaining the same amount of expenses. This will help you break even faster. 

Reduce Costs

Another strategy you can use to lower your break-even point is to reduce your operating costs. This includes reducing overhead expenses, such as reducing staffing, eliminating wasteful spending, and streamlining processes. 

Improve Efficiency

Improving efficiency is an important step for lowering your break-even point. Investing in updated technology and tools can help you get more done with fewer resources, leading to greater profits and faster break-even points. 

Maximize Output

Achieving maximum output from your processes can help you accomplish more with the same amount of time and resources. This can enable you to break even more quickly, as you can spread the costs of production of your products and services across a larger quantity of goods.

Summary

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