Break even analysis is a vital part of a business. It is a valuable part of cost accounting and extends to include a larger analytical model called cost-volume-profit (CVP) analysis. Whenever you need to draft marketing assignments determining the profit and loss percentage of a business, you need to know ‘what is a break-even analysis’. This post aims to discuss everything about break-even-analysis and its significance in business. Read on to know more about break-even-analysis and how to do it.
A break-even analysis can be referred to as a financial tool that helps you to understand the profitability of a product. It will analyse the condition of your business related to a new product or service. In other words, it’s a financial calculation for determining the number of products or services a company should sell to cover its costs (particularly fixed costs). Break-even is a situation where you are neither making money nor losing money, but all your costs have been covered. There is a definite mathematical formula to calculate break-even-analysis of a business. Scroll down to know break-even analysis definition in details.
To understand the break-even analysis in details, you need to know about the two most essential components of the same.
Now, as you know the two most essential components of the break-even margin, let us discuss the methods used to calculate the same.
The main formula of the calculation is dividing the total fixed cost by the contribution per unit (price per unit less the variable costs). The formula of break-even analysis is mentioned below.
“Break-even point in quantity (BEP) = FC/ contribution per unit or FC/P-VC”
Contribution margin is also an important part of break-even analysis. It deals with the contribution margin of different products and calculates the excess price between fixed cost and variable cost. The excess cost is known as the contribution margin. For example, if the price of a product is Rs.100, total variable costs are Rs. 60 per product and fixed cost are Rs. 25 per product, the contribution margin of the product is Rs. 40 (Rs. 100 – Rs. 60). This Rs. 40 represents the revenue collected to cover the fixed costs. In the calculation of the contribution margin, fixed costs are not considered.
As you know the definition of break-even analysis, read on to know the purpose of this analysis in the business.
The purpose of break-even analysis is to boost the business process by analysing the cost accurately. It plays a significant role in different aspect of the business. Keep reading the next section to gain relevant insights.
Thus, it can be said that break-even analysis is an inevitable part of a business. Importance of break-even analysis cannot be denied at any cost.
There are certain limitations of break-even analysis that can determine the success or failure of an enterprise. Although you cannot deny the benefits of break-even analysis, the limitations do exist and can create different problems in a business. Some of the limitations of break-even analysis are discussed below.
Sometimes, the assumption of fixed and variable cost gets confusing. The result of the analysis can also be wrong, especially when the products are not sold at the same price at different levels of output. Therefore, the break-even analysis often fails to find out the actual fixed and variable price.
According to many reports, entrepreneurs often do not get the accurate results of break-even analysis after modifying the pricing strategy. This is indeed a limitation of the process.
Despite its limitations and other shortcomings, break-even analysis is an indispensable part of a business. The importance of break-even analysis is widely agreed upon by leading businessmen the world over.
Break-even analysis acts as a thin boundary between profit and loss in marketing:
Break-even analysis plays a significant role in marketing as it helps to find out the ‘target profit’ of a business based on the cost of operations. It is essential to calculate the volume of sales required to achieve the targeted profit. Here is how it acts as a deciding factor:
The break-even analysis can be referred to as the thin boundary between profit and loss as a company’s marketing plans depend on it. Starting from the changes in price to techniques of production, every decision of a firm is based on the break-even analysis.
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