How to Apply Break-Even Analysis to Your Business

Many small and medium-sized businesses never carry out financial analysis. They don’t know how many units of sales should be made to get a return on their capital. Simone has researched and analyzed many products designed to help small businesses properly manage their finances, including accounting software and small business loans. In addition to her financial writing for business.com and Business News Daily, Simone has written previously on personal finance topics for HerMoney Media. The lower the breakeven point, the easier it is to achieve your sales goal.

The next time you’re thinking about starting a new business, or making changes to your existing business, do a break-even analysis so you’ll be better prepared. If you’re thinking about starting a new business, a break-even analysis is a must. Not only will it help you decide if your business idea is viable, but it will force you to do research and How do you reduce the break-even point? be realistic about costs, and make you think through your pricing strategy. Finding your break-even point will help you price your products correctly. You will know where you need to set your margins to generate the right amount of revenue to break even and begin turning a profit. A company’s goal is to become profitable as soon as possible.

Step 2: Plug in your data

This is variation of the first method in which variable cost line is drawn first and thereafter drawing the fixed cost line above the variable cost line. The added advantage of this method is that contributions at various levels of output are automatically depicted in the chart. If fixed costs increase, the break-even point in units will increase. If fixed costs increase, the break-even point in units will? To find your break-even point, divide your fixed costs by your contribution margin ratio.

As with all restaurant calculations the break-even point requires that the numbers inputted into the BEP formula be as accurate as possible. This means that restaurant accounting e.g. wastage logs, inventories, etc; needs to be as accurate as possible, along with the numbers coming out of the restaurant’s POS system. Again, practicing accurate accounting is essential to how useful and informative conducting a break-analysis can be. Later we’ll go through an example of how to calculate a break-even analysis for a restaurant. There are three components to calculating your break-even point. By looking at each component individually, you can start to ask yourself critical questions about your pricing and costs. If you’re having trouble hitting your break-even point or it seems unreachable, it’s time to make a change.

Raise your prices

Sue-Lynn Carty has over five years experience as both a freelance writer and editor, and her work has appeared on the websites Work.com and LoveToKnow. Carty holds a Bachelor of Arts degree in business administration, with an emphasis on financial management, from Davenport University. In order for a business to generate higher profits, the BEP must be lowered. There are two ways to compute for the break-even point – one is based on units and the other is based in dollars. For example, Company ABC spent $100,000 on manufacturing costs and also acquired revenues worth $100,000. In such a case, the company only achieved its break-even point, which means it didn’t lose anything, but it didn’t earn anything either. For example, BMW can produce much more distinctive and stylish products, appealing to a narrow niche of consumers, in part because they have such a low break-even volume.

With variable costs you only pay for what you use, so you have profitability protection if your sales lag. In effect, you are now sharing the risk of underperformance with your outsourcing vendor. The break-event point can be reduced by increasing the average contribution margin earned on each sale. Another option is to standardize components across product platforms, in order to obtain volume purchase discounts. Yet another possibility is to increase the reliability of products, so that they require fewer warranty repairs. Having high fixed costs puts a lot of pressure on a business to make up those expenses with sales revenue.

Step 1: Gather your data

A company or its business owner can calculate its total revenue, fixed costs, and variable costs through financial analysis. Then it can apply a break-even formula to determine at which point its net profit is zero, either as an amount of revenue or the number of units sold. If non-cash expenses aren’t included in the calculation, a business can also compute its cash break even point. To avoid a loss, you can increase https://accounting-services.net/ the retail prices of your products or determine how to reduce your fixed costs and variable costs. While you have more control over your fixed costs, it doesn’t hurt to negotiate with suppliers to reduce the costs to buy or manufacture the products you sell. Even if it’s just temporarily while you’re experiencing a lull in sales. To understand break-even analysis, divide fixed costs by the contribution margin ratio .

• When you know what your break-even point is, you can discuss and finalize long-term pricing strategies.
• Cost accounting is a form of managerial accounting that aims to capture a company’s total cost of production by assessing its variable and fixed costs.
• As you now know, your product sales need to pay for more than just the costs of producing them.
• Confirm this figured by multiplying the break-even in units by the sale price ($100), which equals $50,000.
• Before we get started, get your free copy of the break-even analysis template here.
• Sometimes costs fall into both fixed and variable categories.
• Discover the products that 31,000+ customers depend on to fuel their growth.

Basically, a business will want to use a break-even analysis anytime it considers adding costs. These additional costs could come from starting a business, a merger or acquisition, adding or deleting products from the product mix, or adding locations or employees. But it’s also a critical element of financial projections for startups and new or expanded product lines. Use it to determine how much seed money or startup capital you’ll need, and whether you’ll need a bank loan. You may have an idea that spurs you to open a business or launch a new product on little more than a hope and a dream. Or, you might just be thinking about expanding a product offering or hiring additional personnel. A break-even analysis will reveal the point at which your endeavor will become profitable—so you can know where you’re headed before you invest your money and time.

Setting revenue goals and targets

In breakeven point, there is no profit or loss in the volume of sales. In other words, it is a point at which no profit no loss situation prevails in the operating activity of a business firm. This indicates that the breakeven point is the minimum level of production at which total cost is recovered and no profit or no loss is sustained.

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You can use the break-even point to find the number of sales you need to make to completely cover your expenses and start making profit. If you sell more than your break-even point, you’re making a profit. But if you sell less, your sales revenue won’t cover your expenses and you’ll operate at a loss. Anytime your cost of production changes, your break-even point will be affected. When production costs increase, it will cost your business more to make each product, increasing your break-even point. It does not consider semi-variable costs or indirect costs that can significantly change the profitability of the product. Suppose ABC company produces three products P1, P2, and P3.

The sale line divides the graph into two parts both horizontally and vertically. When your company reaches a break-even point, your total sales equal your total expenses. This means that you’re bringing in the same amount of money you need to cover all of your expenses and run your business. The average variable cost is calculated as your total variable cost divided by the number of units produced.

Creating a new product

You can use the above formulas to do a break-even analysis. A break-even analysis can help you see where you need to make adjustments with your pricing or expenses. If your business’s revenue is below the break-even point, you have a loss. But if your revenue is above the point, you have a profit. ERP and accounting software with managerial accounting features will typically calculate your BEP for you, but you may want to understand what goes into that equation.

But if you buy 250–300 pairs of jeans, you’ll need to devise a strategy to sell the units in one month. Margin of safety refers to the difference between your breakeven point and sales made. Any revenue you make above your breakeven point is considered the margin of safety. It’s the measured distance you are from being unprofitable. The higher your margin of safety, the lower the risk of turning a loss.