The importance of break-even analysis in making “short-term” administrative decisions lies in some points that we will review, namely:
- Manage the volume of units to be sold: Through the break-even analysis, the company identifies the number of units that need to be sold to pay the cost, the variable cost and the selling price of a personal product, and the overall cost required to evaluate the break-even analysis.
- Budgeting and setting goals: As a result of the fact that the company or the owner realizes at what point the company can provide a break-even, it is simple for them to set the goal and set the budget for the company according to this, this analysis can also be done in setting a realistic goal for the company.
- Safety margin management: In the event of a financial crisis, sales must be reduced in the company. The break-even analysis contributes to the company putting the least amount of sales required to provide profits, with a margin for safety reports, and available to the management to make a high commercial decision.
- Control and cost control: Corporate profit margin can be affected by fixed as well as a variable costs, so through break-even analysis, it is available to management to discover whether there is an effect that causes cost change.
- Helps design pricing strategy: The break-even point can be affected if there is any change in the price of the product, for example, if the selling price is raised, it will reduce the quantity of the product to be sold to the break-even point, similarly, if the selling price is reduced, the company seeks to sell a lot to equalize.
Break-even analysis assumptions
- It is possible to classify comprehensive costs into fixed costs and variable costs and may ignore semi-variable costs.
- Keep cost and revenue functions in line.
- The price of the product may be fixed for a period.
- Illustrate that Yukon's sales and production volumes are equal.
- Keeping fixed costs constant over volume in the field of view.
- It may charge a flat rate to rise the variable cost.
- Assuming stable technology is available and there is no increase in work efficiency.
- The product price may be fixed.
- The price remains an unchanged factor.
- Changes in input prices are distanced.
- In the case of a multi-product firm, a mixture of products is stable.
The significance of the break-even point
A small business owner can sell a huge amount of the finest products that you can imagine, yet without a strong understanding of the importance of accounting, it will not cause the business to profit, to be profitable, it is important to have a business plan and a conscious understanding of the total costs of the products in exchange for the price of the product, Break-even analysis is an essential tool that small business owners can use to break-even and make their business profitable.
Uses of break-even analysis
- New business: If it is for a new project, a break-even analysis is required. It guides management with a price strategy and is practical about cost. This analysis also gives insight into whether the business is for a new product.
- Manufacture of new products: If a company is now going to release a new product, it still has to do a break-even analysis before starting and see if the product increases the expenses needed for the company.
- Change in the business model: break-even analysis even if it brings about a change in any business model eg switching from retail to wholesale business, this analysis will help the company to establish whether the selling price of the product is willing to change.
Strengths and weaknesses of break-even analysis
- Pricing: Break-even analysis gives a more robust basis on which products can be priced. The current financial situation must be looked at and the extent of the ability when it comes to reaching the break-even point.
- Setting revenue goals: In addition to this, doing a break-even analysis can be a great way to set milestone sales goals for the team, if there is a clear number and within a certain time frame, it will be simpler to consistently set revenue goals.
- To mitigate risks: At times, it is not meant to follow business ideas, break-even analysis can contribute to minimizing and reducing risks by moving away from investments or product lines that do not remain profitable.
- Obtaining financing: It is worth saying that the break-even analysis is often an essential component of business plans, if it is desired to obtain financing for a business activity or for the start of a project, it may need to do a break-even analysis, besides, it is possible to make the break-even point Which can be made more comfortable with the possibility of getting profits or getting away from additional debts.
- Unpredictable Demand: Although break-even analysis can indicate when break-even is, it does not give any idea of the strength of the probability of this happening, besides, unstable demand, so even if there is an objection and there is a gap in the market, it may end It was until the break-even point became more successful than initially anticipated.
- Depends on reliable data: The accuracy of the break-even analysis can be relied on as a result of the accuracy of the data, if how you calculate the break-even point is wrong or you are dealing with non-fixed costs, break-even analysis may not be the most useful method in the company.
- Very simple: break-even analysis is best for companies that have one price point, if a lot of products are available at many prices, break-even analysis may be too simple for needs, in addition to this, it is worth saying that costs can change this you may want the break-even point to Evaluation and modification at a later time.
- Ignores competition: Another constraint to break-even analysis is related to the fact that competitors do not enter the equation, eventual entrants to the market may influence demand for products or alter prices, which may cause a break-even point.
What are the limits of break-even analysis?
We may now mention some important limitations to keep in mind while using break-even analysis:
- In break-even analysis, everything is held constant, the selling price may be constant and the cost function is written in, in practice, it will not be the same.
- In a break-even analysis where job constancy is maintained, we are expected in the future with the hypothetical contribution that the cost-revenue-output relationship is valid only on a small amount of output, it is not considered an effective tool for long-term use.
- Profits are considered a function not only of production but are available in other factors such as technological change, improving the art of management, etc., which are ignored in this analysis.
- When a break-even analysis is based on accounting data, as it normally does, it may signify various limitations of this data such as neglect of calculated costs and arbitrary depreciation estimates, and improper allocation of public expenditures, it can only be sound and useful if the particular company has a good accounting system.
- Selling costs are particularly difficult to deal with break-even analysis. This is because changes in selling costs are a cause rather than a consequence of changes in production and sales.
- The easy form of a break-even chart does not imply any provisions for taxes, particularly corporate income tax.
- Both fixed and variable costs must be considered. In calculating the break-even point, the small business owner should be aware of his total fixed costs.