What is break even analysis, and how to apply it to your business
All enterprises conduct a break even analysis to determine the number of units of the revenue required to cover both the fixed costs and variable costs, to ensure the business is profitable. A breakdown analysis is usually conducted by a management accountant or similar to get a clear financial picture commercially.
There are a few different functions of a break even analysis:
1. To determine fixed costs from variable costs
The process is called classification and it’s undertaken to distinguish which costs are classed as overheads and which are the costs that change according to sales activity. Some costs such as staffing are difficult to classify, especially if you upscale with staff to meet periods of high delivery.
2. To understand the contribution margin
After classification of business costs, you then need to work out the true revenue after the variable costs associated with the product or service have been deducted.
3. To define sales expectations
Once you have your sales price point, minus any associated costs and you know your fixed cost obligations, you can then work out how many sales you need to generate over what period, to break even. You can use this to set sales targets and to drive sales and marketing strategies.
4. To react to change
Break even points are subject to change. If your sales suddenly plummet due to a change in consumer behaviour, technical issues, supply issues or another factor, your business revenue may no longer cover your costs. If your revenue decreases, you can look at things like offers, price increases (subject to situation) or a reduction in overheads. Lowering your break even point with reduced fixed costs means you are making it easier to cover your costs again.
The break even analysis should be visible to members of the finance office such as CFOs and management accountants as well as heads of sales, marketing and production or operations.