Break-Even Analysis
A break-even analysis is used by businesses to calculate the
point at which the business stops making a loss and becomes profitable. This is
usually the point at which fixed costs are covered by the revenue that is
generated.
For example, a merchant may sell widgets at ten dollars
each. They may hire a stall at the market at $100 per day. Each widget has a $4
profit margin. So how do you calculate the break-even point? Easy! Simply
divide $100 (for stall hire) by $4 (the profit margin). The result will be a
break-even point of 25. This means that the merchant has to sell 25 widgets to
cover the stall costs. Obviously, this is a simplified example that doesn’t
take account of any associated costs such as stall construction, transport,
meals and other expenses the merchant is incurring.
Break-even analysis for larger companies is much more
complicated. The actual calculation is easy, but the hard thing when trying to
do a break-even analysis is the exact calculation of fixed and variable costs.
These must be estimated with the best possible accuracy for the break-even
analysis to be useful.
Every business plan should contain a full set of financial
forecasts. The break-even analysis is probably the most important statement
that is to be included.
