Do you know your Break-even point?
A Break-even point analysis is a powerful management too, and one that is critical in planning, decision-making and expense control. Break-even analysis can be invaluable in determining where to buy or lease, expand into a new area, build a new plant, and many other such considerations. Break-even analysis can also show the impact on your business of changing your price structure. As the price goes down (and so your gross margin goes down), breakeven shoots up – usually very rapidly. Break-even analysis will not force a decision, of course, but it will provide you with additional insights into the effect of important business decisions on your bottom line
Break-even refers to the level of sales necessary to cover all of the Fixed and Variable costs
FIXED COSTS
Fixed costs are those costs or expenses that are expected to remain fairly constant over a reasonable period of time. These costs are relatively unaffected by changes in output or sales up to the point where the level of operation reaches the capacity of the existing facilities. At that point, major changes would have to be made such as the expansion of existing plant and equipment or the construction of new facilities. Such actions would increase the fixed costs. However, under normal operating conditions, the fixed costs (also referred to as indirect costs, overhead) will remain constant.
VARIABLE COSTS
Variable costs are those costs or expenses that vary or change directly with output. These costs are associated with production and/or selling and are frequently identified as “costs of goods sold”. As compared with the fixed costs which continue whether the firm is doing business or not, variable costs do not exist if the firm is not doing business. Thus, by definition, variable costs are zero when no output is being produced. At that time Fixed Costs are the only cost that will be incurred.
Examples:
Fixed Costs
- Wages/Salaries
- General Office expenses
- PAYG tax
- Utilities
- Rent
- Franchisee fees
- Operating supplies
- Insurance
- Advertising
- Legal and accounting
- Depreciation
- Interest
- Maintenance and cleaning
- Dues and publications
- Mortgage payments
- Interest on loans
Variable Costs
- Sales Commissions
- Lead Fee
- Fuel
- Bad Debts
- Cost of goods sold
- Postage
- Casual Labour
- Benefits
Break-even point is calculated from the most current income statement to identify each cost as either fixed or variable. Fixed costs are independent of sales level, while variable costs rise and fall with sales. Mixed costs involve elements of both. Most costs will fall readily into fixed or variable. For those that don’t, allocate 50% to fixed costs, and 50% to variable.
Once your Break-even analysis is calculated and you will know your Beak-even point (a graph will give a visual picture) you will also learn at what point you begin to make a profit given the Fixed and Variable costs in their present form.
Now you can work on important points to increase profits without investing extra funds and work on ways to lower your Break-even point
1. A possible increase in utilization of existing capacity through reduction of idle time
2. Better repair and maintenance of equipment to reduce downtime – time elapsed from the moment the machine breaks down to the time it get back in service
3. Improved working schedules – labour productivity
4. Diligent purchasing and inventory levels
5. Longer business hours
6. Improved production control
7. Technology improvement
8. Increase prices
Let’s look at increasing prices…
The most obvious way to lower your Break-even point is to raise prices. If prices can be increased without impairing sales (and without increasing costs) the Break-even point will go down. For some companies and products, this is not an option. Remember that attempting to increase profits by simply raising prices can be risky. Unless your customers perceive greater value in your product or service, increasing prices may negatively impact sales.
SUMMARY
Break-even analysis and techniques are the tools that finally tell the business owner when they are making a profit. Break-even graphs and analysis need to be a part of every budget – they enable you to gauge the business’ production rate accurately and gives you additional insight into important business decisions.
You can do a better job of handling cash flow e.g. If you are projecting your sales volume to fall below the Break-even level during slow periods, you can be prepared to closely monitor costs to minimize losses.
You cannot ignore a break-even point! Many businesses have failed because they were not aware of their Break-even point? You may even decide to completely discontinue a product or service after this kind of analysis! And, that may be a reasonable business decision if it is better for you to scrap an idea and invest your time and money in a more profitable direction.
Contact your Jim’s Professional Bookkeeper today to aid you in determining your Break-even Point
Contribution by www.bixbound.com and Dr William R Osgood
Shared with you by – Maureen Millar
Jim’s Bookkeeping Northern Gold Coast (Helensvale QLD 4121)
Maureen Millar is the owner of Jim’s Bookkeeping Northern Gold Coast and she supports small business’ in Helensvale and across the Northside of the Gold Coast. To find out more about Maureen, visit her profile page at http://www.jimsbookkeepingbrisbane.com/maureen-millar.html or request her free report to discover “How to Stabilise & Grow Your Business in 7 Easy Steps“
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