Break even point is determined as the point where total income from sales is equal to total expenses.
It is the point that corresponds to this level of production capacity, below which the company operates at a loss. If all company’s expenses were variable, break even analysis would not be relevant. But, in practice, total costs can be significantly affected by long-term investments that produce fixed costs.
Therefore, a company has to estimate the level of goods sold (or services offered) that covers both fixed and variable costs.
Break even analysis can be used as an additional management decision support tool for assessing the efficiency and effectiveness of marketing strategies.
- This analysis is employed to provide answers to questions such as
- “what is the minimum level of sales that ensure the company will not experience loss” or
- “how much can sales be decreased and the company still continues to be profitable”.
- Break even analysis is the analysis of the sales’ level at which a company (or a project) would make zero profit
- As its name implies, this approach determines the sales needed to break even.
Break even analysis is extremely important
- Before starting a new business (or launching a new product) because it gives answers to crucial questions such as
- “how sensitive is the profit of the business to decreases in sales or increases in costs”.
- This analysis can be also extended to early stage business in order to determine how accurate the first predictions were and monitor where the firm is on the right path (the one that leads to profits) or not.
- Mature businesses must take into consideration their current break even point and find ways to lower that benchmark in order to increase profits.