Using break-even anaylsis to make decisions
The break-even point is a point within a business where the profits equal the total costs. This means that the business is not actually making profit, nor a loss. The break-even point is useful in many ways, such as:
(Note - the break-even point can not help the fixed costs, as they are things such as rent and insurance and have nothing to do with the products sold - although break-even shows how much money is needed to cover these).
There are many, many more reasons as to why the break-even analysis is useful...but I'd be here all night!
(Note - the break-even point can not help the fixed costs, as they are things such as rent and insurance and have nothing to do with the products sold - although break-even shows how much money is needed to cover these).
- It is an easy way of checking the viability of a new business proposal
- Once you know your various break-even points, you can set your long-term pricing strategies. You could keep them the same once initial investment is paid off, or you could lower them as you no longer need to pay that initial investment money
- It doesn't guarantee profit. But, it does show the entrepreneur, and other people involved (e.g. bank) how many customers are needed in order to cover all costs
- If the break-even output is high and very hard to achieve, this may make the entrepreneur look at ways to reduce fixed and variable costs. The break-even analysis also helps the business to identify excessive fixed costs. Since the break-even point is directly related to the fixed costs, reducing and controlling these costs aids the business in achieving a lower break-even point for quicker profitability.
- It provides important knowledge for long-term planning
- Knowing your break-even for areas such as sales, production, operations and investment payback can help you with pricing, debt service and other functions of operating your business
- Break-even points can show if you can still make money when setting discounts or sales etc. If you're not making revenue and profit, what's the point?!
- If you spend money on a marketing promotion, you can determine whether it’s worthwhile by adding the cost of the promotion to your current overhead expense for the time period the promotion is running to determine your new break-even point.
There are many, many more reasons as to why the break-even analysis is useful...but I'd be here all night!
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