What is break even analysis, its benefits and how to calculate?

It is very important to what is break even analysis. In simple terms, the break even analysis is nothing but a financial calculation. It analyzes whether the unit price of the product is able to meet the expense of new ventures, goods, and services. 

The break-even point calculation reveals how much sales target businesses must meet to cover the cost of running a business. It reveals whether you have sold enough goods or not. Break even analysis is significant because it informs at what point businesses will neither earn profit nor face losses. Market demand is not considered by the break-even point for businesses. 

Every business should undergo a break even analysis before introducing new services or investing in new ventures.

There are two different components associated with break-even point calculation. Both fixed costs and variable costs are taken into consideration by the break-even point formula. The components are mentioned beneath.

1. Fixed cost

Fixed cost remains constant throughout the business activities. It does not depend on the sale of goods & services. It includes the salary of employees, expense of equipment, premium on interest, capital interest, and others. 

2. Variable cost

The sum of expenses spent on labor and materials to produce a unit of goods & services is known as Variable cost. It keeps fluctuating depending on the units of goods & services sold. It has a direct connection with company sales. It includes commission earned on sales, shipping expenses, cost of payroll, hourly wages to laborers, etc. 

Total variable cost is calculated by multiplying the price spent on producing one unit by the total units produced.

The production level and desired sales target can be determined using break even analysis. Because the metric and calculations are not used by regulators, investors, or financial institutions, the break-even point calculation is only for the management of businesses.

The break-even point (BEP) is calculated in this kind of analysis. Divide the total fixed costs of production by the price per unit minus the variable costs of production to determine the break-even point for the business. Costs that don't change no matter how many units are sold are known as fixed costs.

The level of fixed costs in relation to the profit generated by each additional unit produced and sold is examined in the break even analysis. A business that has lower fixed costs will typically have a lower break-even point of sale. For instance, assuming that variable costs do not exceed sales revenue, a business with no fixed costs will automatically have reached profitability upon the first product sale. 

You won't be earning any profit or losing any money at the break-even point, but it assists in covering all of your business's expenses. Your company's sales are pure profit after a break even analysis. In a nutshell, break even analysis helps you figure out when your business or goods & services will become profitable, and investors use it to figure out when they will start earning profit and regain their investment.

By itself, a break even analysis has numerous applications. However, it is also an essential component of financial projections for startups and expanded or new product lines. Businesses utilize it to determine whether you will require a bank loan and how much startup capital you will require.

Break-even point analyses are used by more established businesses to assess the risks associated with a variety of activities, including the transition of innovative ideas into production, the addition or removal of products from the product mix, and other scenarios. 

Budgeting for an additional employee is one example. A break even analysis will show how many more sales are needed to cover the costs of hiring the new employee.

Every business owner should know the significance of break even analysis due to the following points. 

The break-even point analysis can be done by dividing the fixed costs of a business by the per unit price of sales (minus per unit variable cost).

Let’s understand this with a practical example.

A company runs a business manufacturing and selling shoes. Their fixed cost amounts to $300000. The variable cost involved in manufacturing one shoe is $200. Each shoe is sold for $500.

Businesses can do the break even analysis by the following method. 

300000/(500-200) = 3000 

Therefore, the company needs to sell 3000 shoes to reach the break-even point. 

A break even analysis is used to figure out a company's cost structure or the number of units that need to be sold to cover expenses. When a company achieves the break-even point, it not only recovers all of its expenditures but also does not incur any losses. The relationship between revenue, fixed cost, and variable cost is examined using the break-even calculation.

A business with low fixed costs typically has a low break-even point of sale. A break even analysis is crucial for a new venture. It is cost-effective and serves as a pricing strategy guide for management.

Additionally, this analysis indicates whether the new company is successful. Before launching a new product, an established business must conduct a break even analysis to determine whether the product will necessitate additional costs.