Advantages of Calculating Breakeven Point

Whenever a person starts a new business the first question that arises in his mind is that when his business going to make a profit? To be honest, it is nearly impossible to predict the exact amount of company’s sales and profits as there are many different kinds of products of the company, also has many customers of varying demand, and the amount of interaction between the price, promotion and number of units sold also varies. 

Despite of all these challenges that the company face in the real world, the financial experts and analysts have discovered a technique called a break-even point or break-even analysis that could somehow be used to answer the queries of yours.  

Breakeven Point:

The breakeven point of any company is that point at which the company’s sales could exactly cover its expenses. At this point, the company does not earn any money at all. If the sales increase from that particular point, then the company will earn a profit, and if the sales decrease from the breakeven point then the company will face loses. 

Advantages of Calculating Breakeven Point:

There are certain situations in which calculating the breakeven point could prove to be of real use. Some of them are:
  • ·         The maximum amount of profit that the company could generate could be calculated after calculating the breakeven point as after that point the remaining capacity could be utilized in making profits.
  • ·         The effect that replacing a variable cost with a fixed cost can create on the company’s profits could be determined
  • ·         The increase or decrease in the profits because of the change in the product price could be measured.
·         The company can also measure its ability to bear the extent of loss in case of low sales.

Calculation of the Breakeven Point:

The experts have developed a simple formula to calculate the breakeven point. It can be calculated by simply dividing the total fixed expenses with the contribution margin. To get the contribution margin, you need to divide the sales minus variable costs by total sales. Therefore, the formula for the breakeven point could be:

To get the more precise and accurate breakeven point, the company should remove the non-cash expenses such as depreciation while calculating the total fixed expenses of the company. 

Let us suppose that a company A wants to buy the company B but, before that it want to know the breakeven point of company B so that the profit margin could be known. The information about company B that is available is as follow

Maximum Sales Capacity                   $5,000,000
Operating expenses                             1,750,000
Average Sales                                     4,750,000
Gross margin percentage                     35%
Breakeven Point                                  $5,000,000
Revised breakeven level                     $3,929,000

So, from the given information, it is quite clear that the breakeven point of company B is very high and hence the opportunity of earning the profits is very less. The next step that company A can take is to try to find out the margin by using which the breakeven point can be declined.

How to Reduce the Breakeven Point:
Any of these measures could reduce the breakeven point:

·         Reviewing the fixed and variable cost on continuous basis so that any excessive costs could be removed

·         The product margins should be reviewed and those with highest margins should be sold more
·         Outsourcing the activity with higher fixed cost would turn the cost into per unit variable cost which is comparatively lower and hence help in reducing the breakeven point

·         The price reduction strategy could be useful at times, but it also increases the breakeven point. Try to reduce it by eliminating any type of coupons or other offers by the company.

 Hence, it is really important for the company to find the breakeven point and should try to keep it as much lower as it can so that the chances of earning profits increase.

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Break Even Point And How To Calculate It

When you are running or managing a business at a smaller level, you are dealing with small figures and the number of clients is also limited too. However as you most past the small business standard and enter into the big market, things start changing around you. The evaluation techniques and methods used in past become outdated, the data management tools are no longer effective for huge number of sales and clients and of course, you need more man power equipped with better computing technology to run business smoothly.
For a business owner/ manager, it is important to know how different costs and values will behave once the number of sales and contracts expand. There is a method used in economics called cost-volume-profit analysis that studies the interrelationship of sales, net income and costs. In most of the planning decisions, this analysis plays a vital role. The main reason behind this analysis is to determine how the values of costs and profit change when there is change in volume of sales. This study is termed as Break Even Point Analysis. With the help of this evaluation, businesses can get a better understanding of how things will work out if they adapt a particular course of action.

In business, there are two types of costs. One is a fixed cost and the other is variable cost. Fixed costs are those costs that don’t change even if there is change in the volume of sales but on the other hand, variable costs are dependent on the volume of sales. If the sale volume decreases, the variable cost increases and if sale volume increases, the value of costs decreases.

Let’s assume that a toys company “A” is selling its toys on a retail stand that is located at “B” mall and they want to expand their market. The company is looking to enter into a new mall named “C” so they can expand their sales but for that reason, they have to negotiate on a lease of retail stand. Considering the lease price and other expenses, company has to determine its pricing and they come up with following plan

Selling Price Per Toy: 20 (100%); Variable Expense: 10 (50%) ; Contribution Margin: 10 (50%) ; Fixed Expenses: $700.

Before entering into a lease contract wit
h “B” mall, the Toy Company “A” will have to answer certain questions before making such kind of decision.

Break-Even Point Computation

Q: What would be the Break Even Point of company in terms of number of Toys sold and dollar of sales?
While evaluating the break even point, the revenue is considered equal to the costs, no profits or losses are considered as well.

Unit contribution approach is used in this case in which each piece of toy sold contributes a certain value to the fixed costs. A toy sells for $20, variable expense is $10 and contribution to fixed cost is $10 too.
Total fixed cost is $700 so if we divide this figure by $10 ($700 / $10), we get a sale volume of 70. This means that the break even point of company is 70. The company can only start generating profit after selling 70 toys each month.

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