The break-even point is when the total costs equal total revenue. The total cost comprises both the fixed and the variable cost. For any business, it’s important to determine their break-even point to help them in the decision-making process. Some of the objectives of break-even analysis are listed as follows.
Determines the Number of Units to be Sold
The calculation of break-even analysis is done so that the owner knows the number of units to be sold in order to break-even i.e. no profit and no loss. The selling price of each product, the variable cost of each product, and the total fixed costs are required to determine the break-even analysis.
Helps in Budgeting and Setting Targets
Since you know at which point you can break-even, you accordingly can set budgets. Also, break-even analysis can be used in setting realistic targets for the business. This is possible because you know at which point a business is able to achieve profits and hence, you can use this break-even point to set benchmarks or targets for your firm. If you are not well-versed in analyzing your finances, then hire a financial controller who will help you make a budget and set realistic targets for your firm.
Determine the Margin of Safety
The margin of safety can be calculated by subtracting the current level of sales less the break-even point and then dividing it by the selling price per unit. In the event of a recession or an economic downturn, sales tend to decline. So, with the help of the break-even analysis, you can determine the minimum level of sales required to ensure you make profits. By knowing the margin of safety for a particular product or service, managers can make better business decisions.
Cost Control and Monitoring
Since managers know that the fixed and the variable costs affect the profitability of the business, they can see the effect of the changes to costs with the help of break-even analysis. It helps them to determine the extent of changes in costs affects the profitability and the break-even point.
Helps Devise a Pricing Strategy
Any change in selling price can affect the break-even point. For instance, if the selling price is increased, the number of units to be sold to break-even will be reduced. Likewise, if the selling price is reduced, a firm needs to sell more to break-even. Thus, with the help of break-even analysis, managers can decide whether they need to modify the selling price and devise a pricing strategy for the same.
These are just a few objectives of break-even analysis mentioned above. Break-even analysis helps businesses make quick financial decisions and so, its importance cannot be ignored. For more information on objectives and creating break-even analysis for your firm, consult a professional accounting firm or hire a financial controller who will aid you in making your business decisions.