Let’s suppose you have total fixed costs ‘f’, variable costs per unit ‘v’ and sales price ‘s’ per unit. Your break-even equation will be:
where, ‘b’ is the number of units produced
Break-even point is also represented in monetary terms. The precision with which you compute each of these components is crucial and will determine how accurate your calculation will be. So, ensure your financial information is reliable. That is why you must seek expert help for vetting your data and arriving at meaningful results. For services industry, the analysis a little more complex.
Your variable costs may be those that follow your sales – if sales go up, they’ll go up as well. They will most commonly include labor, materials and direct overheads. If you have a production facility, there will be some part of your overheads that varies with the level of production. This portion is also included in variable costs. To give an illustration, if you sell specific widgets, you will first have to procure them from a seller. The purchase price, therefore, is a variable cost – the more you sell, the more you will have to buy. If you sell solutions, the variable cost may be the fee charged by your service providers. Once you have identified what your variable costs are and you know the sale price, you will be able to compute your margin. This should be done at the individual item level, as well as, at the gross production level.
Your fixed costs are the last component of this analysis. They are those costs that do not change regardless of your sales levels and therefore, do not have any per unit implication. Expenses like rent, utilities, phone, insurance, administrative staff, fall into this category. Again, make sure that your accounting records are precise and that you could rely on the numbers you will be using. Before proceeding, here’s one more definition to consider on a per unit basis:
The above discussion proves that your level of sales should be such that the total contribution margin from all the units produced is at least sufficient to cover your fixed costs. In nutshell, the contribution margin and fixed costs both impact your break-even point. But what happens when you produce more than one type of products or services? The cost-volume-profit analysis, one of the most beneficial outcome of break-even analysis comes into picture. It is a detailed system of analysis that aids the management in deciding the most profitable mix; inclusion or exclusion of a product/service; quantity output under each line and so on. You can make some intelligent decisions relating to your item pricing, variable costs and overhead. On the other hand, cost-volume-profit analysis may bring to your attention the areas of inefficiency that have, so far, been hidden from plain sight, such as non-performing SKUs, regions of overspending and unprofitable customers.
Many small businesses fail to appreciate the significance of cost accounting and break-even analysis for critical management decisions and company profitability. In reality, these tools can bring significant benefits not only in the form of added profitability, but also as an edge over competition. We assist small and medium businesses, including growth companies, in deriving most out of financial analytics. Let us know your requirements at www.eurionconstellation.com or drop a line at firstname.lastname@example.org