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.
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.