As an entrepreneur, you always aim to have a successful business. However, just like any other undertakings, starting and running a company isn’t only about success. It also comes with some risks and challenges, especially if you don’t know how to handle the intricacies of your business operations. Thus, it’s crucial for every entrepreneur to conduct research and effective planning before running the company. This is where a break-even analysis enters the picture.
Keep reading this article to know everything about a break-even analysis and how it can contribute to your business’ success.
Break-Even Analysis: What Is It?
Primarily, break-even analysis refers to a tool that is used by almost all industries and business sectors. It also serves as a financial calculator that determines the exact point at which your company will become profitable.
Aside from being used as a financial calculation, break-even analysis is a formula used to compute the number of products you need to sell to finance your expenditures. This means that when you’re at the break-even point in your business, it goes to show that you’re neither making nor losing money, plus you’ve covered all your costs.
However, to better understand how a break-even analysis works for your business, below are the things you need to familiarize in order to come up with an accurate calculation:
- Variable Costs – These costs are dependent upon the product sales, which include processing of the payment, temporary labour and materials, and other things related to delivery/service of products.
- Fixed Costs – These costs are fixed regardless of the total number of product sales. Also known as overhead costs, these typically include rent, utilities, insurance, salaries of the employees, and other expenses.
- Price – This usually refers to the starting price that most businesses provide for their products or services.
- Revenue – This refers to the money businesses earn from their customers after buying their products or services within a specific period. This is also known as the gross income, which is computed by multiplying the number of products sold by the price of the product the company intends to sell.
- Contribution Margin – This refers to a margin that demonstrates the number of revenues intended to cover the fixed costs. This is the difference after subtracting the variable costs from the revenues.
Now that you know what break even analysis is and the factors involved in the analysis, it’s time to get familiar with the calculation of the break-even point to figure out when you’ll turn a profit.
To have a better understanding of how to do it, you can check some resource websites and stay updated with the latest business insights and news.
Break-Even Analysis: How Can It Become Beneficial To Your Business’ Success?
As mentioned, a break-even analysis plays an integral part in the success of your business. By knowing the break-even point of your company, you’ll significantly reduce the chances of failure.
Here’s how break-even analysis can help ensure your business’ growth and success:
Finance Your Business
Typically, you need some investors to finance your business and become successful in the future. But, before you can do that, you need to prove to your investors that your business plan is feasible and has the potential to grow your business. And to do this, performing a break-even analysis can be an excellent idea.
For example, if the result of your analysis is more on the brighter side, then it goes to show that taking more investors can be the right business decision.
Focus On Your Business’ Point Of Profitability
Knowing that your business isn’t turning a profit is something that you shouldn’t take lightly. Besides, the primary goal of every business is to become profitable as soon as you launch it. Thus, if you don’t want your business to take a worse turn anytime, it’s essential to do a break-even analysis to determine its point of profitability.
When you calculate your business’ break-even point, you’ll have an idea of whether it’s generating profit or not. And the more you know your profitability numbers, the more you can keep your company on the right track.
Set The Right Price For Your Products Or Services
In the business world, the price of the products or services can be one of the important factors that companies take into account to succeed. When you set the right price, you’re able to make your business profitable. However, just like other business aspects, the selling price you set for each product or service can impact your company’s overall profitability. This is where the conduct of a break-even analysis becomes extremely important.
By determining the break-even point of the different price levels, you’ll get some insights on how your selling price can influence other factors. You can use the results of the analysis to set the optimum price that suits your consumer affordability, inventory management, and many more.
Help Set Achievable Budget Targets
In addition to funding your business, a break-even calculation and analysis can also be a useful tool for a budgeting process. The more you know how much your company will become profitable at one point, the more you can set realistic and achievable budget targets. After all, setting enough budget can make sure you can handle your business operations financially and efficiently.
Determine The Sales Volume Required To Avoid Losses
With a break-even analysis in place, you’ll know the sales volume needed to produce sufficient revenue to cover your business’ expenditures. For example, the calculation can help you figure out the number of products your company needs to sell to attain the break-even point and make sure to avoid the losses that might be incurred within a specific period.
This means that when your total sales in a month are way below the required number, it can be a sign that your business isn’t generating enough income. But, when your sales volume is within or more than the needed quantity, it can be an indication that your company is doing well and has a huge potential to succeed in the coming years.
Help Make Smarter Business Decisions
Sometimes, entrepreneurs like you make business decisions based on what they feel about a particular situation. For example, if you think and feel that an undertaking is suitable for your company, then you’ll more likely go for it. While making decisions based on emotions might be good, it’s still not the best recourse.
If you want to become a successful business owner, you need to anchor your decision-making process based on facts. This is one of the reasons why conducting a break-even analysis is essential. With this analysis, you can get the most out of useful data, which helps you make smart business decisions.
Implement A Better Financial Strategy For Your Business
Aside from your budget, having a solid financial strategy can go a long way in ensuring the success of your business. And by doing a break-even analysis, you can utilize the information to strategize and make sure your finances work well moving forward. Specifically, the information you get from the analysis can help you determine the proper timeline by which you can generate enough profits for your company.
Moreover, when you perform a break-even analysis, you can also come up with practical ways to minimize your business’ break-even point. You can do this by increasing the selling price, decreasing the fixed and variable costs, and many more.
Schedule Product Inventory Levels
In order to increase product sales over a specified time, you probably need to stock sufficient inventory. This means that enough stocks should be available to your clients at a given time. However, you might not be able to prepare your inventory stock unless you have the figures that can guide you throughout the process. You can do this by making a break-even calculation.
Not only that, but the information provided by a break-even calculation allows you to create an inventory plan and set a re-stocking schedule based on your company’s cash flow.
Help Mitigate Financial Risks
Starting a business is never easy. More than the successes, you can also experience some challenges along the way, which can affect the stability of your company. Because of this, using a break-even analysis can be a good option. The calculations can help limit the financial stress caused by your business decisions.
For instance, you can use the break-even chart to warn you about a business idea that you need to avoid. Remember, by mitigating risks, you can reduce the adverse financial effects that not-so-good decisions can bring to your company.
Now that you’ve learned the basics of break-even analysis and how it can benefit your company, you can be more confident in running your day-to-day operations. While you have to spend money to generate income, knowing your company’s break-even point can be crucial to its success.
So, whether you’re starting or running your own business, be sure to consider a break-even analysis when making relevant business decisions.