Introduction to Break-Even Analysis
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Break-even analysis is an economic tool used to determine the number of units required to cover a company's fixed and variable costs, where total revenue equals total costs. It assists organizations in budgeting, setting targets, managing safety margins, monitoring costs, and designing pricing strategies. This analysis is especially crucial for new ventures and product launches, helping management make informed decisions about profitability and financial planning.
Introduction to Break-Even Analysis
- 1. Dr. C.V. Suresh Babu (CentreforKnowledgeTransfer) institute
- 2. • What is Break-Even analysis • Formula • Example • Why Break-Even Analysis • When to use Break-Even Analysis • Uses of Break-Even Analysis Discussio n (CentreforKnowledgeTransfer) institute
- 3. • A break-even analysis is an economic tool which is used to determine the cost structure of a company or the number of units needs to be sold to cover the cost. • Break-even is a circumstance where a company neither makes a profit nor loss, but recovers all the money spent. 3 • Break-even analysis is used to examine the relation between the fixed cost, variable cost, and revenue. • Usually, an organization with low fixed cost will have a low break- even point of sale.
- 4. 4 A break even point analysis is used to determine the number of units or Rupees needed to cover total costs (fixed and variable costs). Break Even Analysis in refers to the point in which total cost and total revenue are equal
- 6. Therefore, to determine the break-even point of Companies premium pen will be: = ₹1,00,000 / (₹12 – ₹2) = 10,000 Note: Hence, given the variable costs, fixed costs, and the selling price of the pen, Company would need to sell 10,000 units of pens to break even. 6 Weldon Co. sells Pen. The company first determined that the fixed costs of Company are • a lease, • property tax, • salaries, which make a sum of ₹1,00,000. The variable cost linked with manufacturing one pen is ₹2 per unit. So, the pen is sold at a premium price of ₹10.
- 7. • Manages the Size of Units to be Sold: With the help of break-even analysis, the company or the owner comes to know how much units need to be sold to cover the cost. The variable cost and the selling price of an individual product and the total cost are required to evaluate the break-even analysis. • Budgeting and Setting Targets: Since a company or the owner know at which point a company can break-even, it makes it easy for them to fix a goal and set a budget for the firm accordingly. This analysis can also be practised in establishing a realistic target for a company. • Manage the Margin of Safety: In financial breakdown, the sales of a company tends to decrease. The break-even analysis helps the company to decide the least number of sales required to make profits. With the margin of safety report, the management can execute a high business decision. • Monitors and Controls Cost: Companies profit margin can be affected by the fixed and variable cost; therefore, with break-even analysis, the management can detect if any effects are changing the cost. • Helps Design Pricing Strategy: Break-even point can be affected if there is any change in the pricing of a product. For example, if the selling price is raised, the quantity of the product to be sold to break -even will be reduced. Similarly, if the selling price is reduced, a company needs to sell extra to break-even.
- 8. is Break even analysis used? • New Business: For a new venture, break-even analysis is essential. It guides the management with pricing strategy and be practical about the cost. This analysis also gives an idea if the new business is productive. • Manufacture New Product: If an existing company is going to launch a new product, they still have to focus on break-even analysis before starting, and see if the product adds necessary expenditure to the company. • Change in Business Model: Break-even analysis works even if there is a change in any business model, like shifting from retail business to wholesale business. This analysis will help the company to determine if the selling price of a product needs change. 8
- 9. • It helps to determine remaining/unused capacity of the company once the breakeven is reached. This will help to show the maximum profit on a particular product/service that can be generated. • It helps to determine the impact on profit on changing to automation from manual (a fixed cost replaces a variable cost). • It helps to determine the change in profits if the price of a product is altered. • It helps to determine the amount of losses that could be sustained if there is a sales downturn. 9
- 10. Additionally, break-even analysis is very useful for knowing the overall ability of a business to generate a profit. • Therefore, it's the management responsibility to monitor the breakeven point constantly. • This monitoring certainly reduces the breakeven point whenever possible. In the case of a company whose breakeven point is near to the maximum sales level, this signifies that it is nearly impractical for the business to earn a profit even under the best of circumstances. (CentreforKnowledgeTransfer) institute