HOW TO CREATE A BREAK-EVEN ANALYSIS FOR YOUR BUSINESS
DEFINING BREAK-EVEN ANALYSIS
Break-even analysis is an accounting or bookkeeping tool that helps a company identify the best period when the business or their new product will be profitable. To make it simpler to understand, it is a calculation used to identify the quantity of products that a company needs to sell in order to cover its operational costs.
It is a point where a company is neither making or losing money, however, the costs of operating the business are covered. It is especially valuable in determining the relation between revenue, fixed cost and variable cost. Entities with low fixed costs generally have low break-even point of sale
WHEN TO USE BREAK-EVEN ANALYSIS
Break-even analysis is vital for when you are starting a business. If you are planning to create a business or if you have already taken the first steps in developing a business, then it is highly recommended for you to be familiar with this financial tool. In fact, this analysis is commonly performed by bookkeepers before an entrepreneur launches. This is to ensure that the businessowner can sort out reasonable products prices and get an understanding of how viable the business concept is. Aside from providing basis for the pricing strategy of a business, this data is also useful in realising the cost of starting a business.
Break-even analysis is also important for when a company is creating a new product. Existing businesses commonly use this data before deciding to launch a new product, especially if the new product will add considerable expenses.
Lastly, break-even analysis is a good tool to use for when an organisation is changing their business model. For example, if a company is converting from retail business to wholesale business. The operation cost and other expenses will significantly change, and this analysis can be a great way to help a business set their selling price.
COMPONENTS OF BREAK-EVEN ANALYSIS
There are few vital components which can help determine the result of break-even analysis. However, there are the two most important components are fixed cost and variable cost.
Also known as ‘overhead costs’ these are the expenditures needed for operating a business. These commonly include labour costs, taxes, salaries and wages of employees, rent of property, depreciation costs, energy costs, interests, etc. While these costs are directly associated to the level of production, the same cannot be said in terms of the quantity of production. These are costs which are carried by a company even if the said entity is not producing goods or offering services. As its name suggests, these are constant expenditures. An experienced bookkeeper in Melbourne can be your guide towards determining you’re the fixed monthly costs of your company.
Variable Per Unit Costs
As its name suggests, this pertains to the cost of manufacturing one unit of a product that you are offering. These are expenditures acquired when producing one unit of goods or when purchasing the product in wholesale. Unlike Fixed Costs, these are company expenditures that will vary – meaning they may decrease or increase depending on production volume. These costs include transport, packaging, cost of raw material, fuel and other expenditures that have to do with manufacturing a product.
UNIT SALES PRICE
Another component that needs to be taken note of is the unit sales price. This is the amount received by a company for a single unit of a product. Determining the unit sales price is vital since it directly affects the sales volumes. In general, this is determined by a businessowner after reviewing the financial forecasts together with their bookkeeper. A businessowner may change it after the company reaches the break-even point. Nevertheless, for calculation purposes, this still needs to be identified beforehand.
Typically, the unit selling price will change after reaching the break-even point. However, needs to be determined for the calculation purpose in the first place
CALCULATING BREAK-EVEN ANALYSIS
The basic formula for calculating break-even point is:
Break-Even = Fixed Costs/ (Unit Sales Price – Variable Per Unit Cost)
Here is a simple example to help make this easier to understand:
Let us just say that a business has a fixed cost amounting to $30,000. They have variable per unit cost of about $25, and their unit sales price amounts to $40. Following the basic formula, fixed costs divided by the unit sales price minus the viriable costs, 30,000/(40-25) = 30000/15 = 2000. With this, we can deduce that the business needs to sell about 2000 units of their product first, before they gain profits. Thus, it will help the company set their target sales in their business strategy or plan.
SIGNIFICANCE AND BENEFITS
Many businesses neglect this vital accounting tool, either believing that it is unnecessary or due to lack of knowledge thereof. Getting guidance from a bookkeeper in Melbourne during the first stages of business development, will provide insight as to the many benefits your business can get from using the data from this analysis. In case you don’t know yet, break-even analysis can be used in many ways.
Make Smart and Informed Decisions – Knowing your business’ fixed cost, variable per unit cost and unit sales price will help making decisions easier. In addition, entrepreneurs are also satisfied, knowing that their decisions are based on concrete facts and informative figures, and not on instincts.
Prevent Losses – Launching a new business unit or product in Melbourne can be quite risky. However, using data from the analysis, an entrepreneur can significantly reduce this risk. Instead of implementing bad ideas, the data from the break-even analysis carried out by a bookkeeping in Melbourne will lead a company towards focusing on viable business plans and strategies.
Find missing expenses – Using a complete break-even analysis, a businessowner can also catch missing expenses. With a lot of happenings going on in a business, especially for startups, it is highly possible that a few expenses are forgotten. Break-even analysis gives entrepreneurs data that will help them review all financial commitments to help them figure out their break-even point. Thus, it also decreases the number of blind corners and helps entrepreneurs prepare for them.
Product Pricing – Businessowners can also designate the right prices for their products and services using this tool. In addition, it will also help you calculate the amount of time you need to achieve the break-even point. Generally, products with very low unit price will also increase the time needed by a company to attain the break-even point. Therefore, it is imperative for entrepreneurs to decide on the most ideal price to keep the business afloat before reaching the break-even point. One of the main benefits of this analysis is that it can be utilised as a tool for determining the most reasonable and profitable price of a service or product without the need to increase the current price. A bookkeeper with significant amount of experience can help you in decide on the correct figure.
Setting revenue targets – With the use of this accounting tool, setting target revenues also becomes possible. Once your bookkeeper in Melbourne provides the complete analysis, you will find out how much your business needs to sell to be profitable, which will also help businessowners and their team to set realistic sales goals.
Fixed Costs Analysis – Break-even analysis also helps ensure that all fixed costs such as salaries and insurances, rental lease payments, and property taxes are covered. The data in the analysis will get you a good understanding of whether the fixed costs like the rental cost or the price of raw materials, is making it difficult to sustain the business. If so, you can decide on renting a smaller or cheaper place for your office in Melbourne or you may also look for a new supplier that offers cheaper price for your raw materials without compromising the quality of your product. As such, you can also make sure that your business is making profits in advance.
Productivity Motivation – Data from break-even analysis can be used to boost business productivity. Having a dedicated goal that you need to achieve such as break-even point will give you and your employees become more enthusiastic and passionately work to attain your goal as soon as possible. Aside from becoming enthusiastic, it can also help boost the morale of your workforce as they realise that your company is one step closer to your goals.
Forecasting – Business can also make use of the data from this analysis to expand their business, to introduce a new product, or to build a new unit. The break-even analysis carried out by a bookkeeper in Melbourne can be used to set goals and identify the number of sales needed to cover the overhead costs of the business expansion, new product, or new unit. While it is best to leave forecasting to a skilled and experience bookkeeper in Melbourne, it is still a crucial element of a business that benefits from break-even analysis.
Get Fund for Business – One of the most significant benefits of break-even analysis is that it helps entrepreneurs get outsiders to fund their business. These outsiders can either be money lenders, banks or other companies who are interested in finding out the business’ break-even point. The complete analysis is a proof that an entrepreneur’s plan is feasible. Thus, giving outsiders confidence in the ability of the business to gain profit. Apart from this, the data from the analysis can also be a used by an entrepreneur before deciding if the loan is worth taking or not.
If you intend on starting a new venture or if you want to come up with a new product, it is important to get the services of a bookkeeping firm in Melbourne to determine your product line or company’s break-even point. This will help you identify the business’ success probability or if the business venture is worth it. Ultimately, you want to prevent yourself from getting into financial trouble. And this is only possible if you have the help of a bookkeeper in Melbourne, who can perfectly carry out a break-even analysis.