Break-even analysis is a process by which an enterprise can make a decision regarding how much it needs to produce and sell finished products. This allows you to determine when you can cover the expense item.
With a regular analysis of these indicators, you can maintain your position in the market of goods and services and feel confident in a competitive environment. And this will help the organization not only stay afloat, but also rise among other firms.
Breakeven
To conduct a break-even analysis, you will need to have a list of organization indicators that are relevant to the main ones. The first step is to identify as accurately as possible the obligatory and recurring costs. It should include the costs of paying taxes, buying raw materials in the shop, for manufacturing products, remuneration of employees, equipment, advertising campaigns, packaging of finished products, payment of utility bills, lease of land or premises, and much more.
In the break-even analysis process, all expenses are compared with the income from the sale of goods and services. The goal is to choose a specific period, calculate the amount of sales revenue, calculate all expenses and compare whether the income can fully cover the expense item. With the correct calculation, it will be clearly visible how many units of goods for a certain period of time need to be manufactured to cover costs. You can also calculate how much goods you need to produce, so as not just to go to zero, but to make a profit.
Break-even analysis is even beneficial for some reason:
- the ability to make predictions;
- after receiving the result, you can make adjustments to the work process;
- You can release new products using old metrics.
- can be used as a starting point and make predictions.
Breakeven
In conducting the activities of the organization, the business owner must know the situation with the financial situation of his production. Many people tend to attribute such knowledge to assumptions rather than to reliable calculations. Most entrepreneurs rely on their intuition, make assumptions and guesses. All analysis is based on cash settlement from the cash desk. Rarely what entrepreneurs do break-even analysis of the enterprise. Some at the same time develop business projects. The data obtained on its basis will not be reliable, since all business plans are made according to one template, and they are used to attract investors. Small enterprises tend to make such mistakes; they are much less common among medium-sized companies. Many people believe that the breakeven analysis of an enterprise is a tool that works exclusively with finances, and only competent economists and accountants with experience can work with it. But this is completely wrong. Such calculations are required by entrepreneurs, those people who are responsible and responsible for all decisions.
Break-even is the financial situation in which the costs of the organization can be fully offset by manufactured and sold products. The amount of profit in this case is zero. During the analysis, answers to the questions should be received:
1. What amount of income do I need to have so that all costs can be covered?
2. How much should be manufactured products or services rendered to cover the costs of the organization?
The analysis does not end there.
To calculate the costs should be divided into two categories:
1. Mandatory expenses that are available every month
2. Recurring expenses.
Mandatory expenses include all expenses of the organization that are independent of the services provided.
This includes all costs that are constant every month. For example, employee salaries, taxes, insurance premiums, utility bills and more.
Periodic include all costs that are completely associated with production. For example, the purchase of the necessary material and raw materials, transportation costs, the remuneration of employees who work piece-work. This may include all the costs that are necessary for the manufacture of one unit of goods.
When compiling an analysis of the break-even of the organization, data that does not change for a certain time are taken into account. In reality, everything is different, and there are many unforeseen situations that can adversely affect the enterprise. If the business owner wants to get accurate calculations, down to cents, then this option is not used. Since during the analysis it is possible to obtain a dependence on how the size of profit changes in relation to costs.
When analyzing the breakeven of production, you can see how profit, net income and expenses depend on each other in a certain period of time. The goal is to clarify the fluctuations in finance in the case of varying activity of production.
Break-even is a state as a result of which the organization does not receive profit and at the same time does not bear losses, it works at zero. To obtain net profit, income from sales is required. Profit is expressed in the number of manufactured products that must be sold and subsequently cover all expenses of the organization.
The task of breakeven analysis involves the search for a break-even point, that is, the state of the organization in which you can produce a minimum of finished products and work at zero - to cover all costs. Thus, the organization has no gains and losses. The amount of income received allows you to purchase materials and raw materials for production and pay the required monthly costs.
Methods used in the work
To conduct an accurate analysis and search for a critical point, it is worth knowing what factors can affect breakeven.
One of the factors is production volume. In those cases when the production indicators remain unchanged and do not change over time, the analysis was done accurately. A low level indicates that the organization is successful in the market. Other factors can influence the breakeven level. For example, the number of employees, construction work and much more.
In practice, there are several methods of breakeven analysis, but the most popular are three:
- mathematical;
- gross profit;
- graphic.
Mathematical is considered a control method
It is used to determine the break-even of an organization using formulas. Many formulas are used to search for profits, but among them one can be distinguished, which is currently the most popular. It is expressed in the following way: the amount of profit can be found after all costs have been taken from the organization’s profit, which include mandatory and recurring expenses.
The method for calculating gross profit is also called marginal revenue. This method is alternative if it is impossible to use the mathematical option. In this case, it is customary to use the following formula: to search for marginal income, it is required to add the profit received to the amount of expenses.
Graphical method
Using the graphical method, they try to find a point that will be break-even, for this a graph is built. It marks income and expenses. Each indicator is marked as lines. The point at which these lines intersect will be considered break-even.
These methods are used to conduct research in a certain period of time. For long-term use, they are not recommended.
Margin analysis
In order not to conduct business at a loss, you need to find a point that is break even. The ideal option is the moment when the organization receives income. But for this, an equilibrium must be determined at which the proceeds will cover expenses, and the company will go to zero.
All calculations must be carried out without VAT and tax. This is due to the fact that there are cases when some of the costs are taxed, and the rest is not. Therefore, in the calculations it is better not to take into account the data that contains taxes - this will avoid errors in the analysis.
To search for the necessary data, a margin break-even analysis is suitable, in which there is a division into mandatory and recurring expenses.
In the process of activity, all expenses can be classified as permanent only conditionally. This is due to the fact that every year prices are rising, therefore, fixed costs are also increasing. Thus, if you add up all the costs, you get the total costs. To determine the profit, you will need to subtract expenses from the amount of income received.
If you transform this formula and the fate of the division of expenses, then to calculate net profit, you will need to subtract mandatory and recurring expenses from the amount of profit.
Margin income can be calculated if periodic expenses are subtracted from the organization’s income. The amount of income received is required to cover mandatory expenses and income. Thus, compulsory expenses should not exceed the amount of marginal income. Such income should not be negative. Each product sold will increase the minus in which the company is currently working.
The financial analysis
Break-even financial analysis is a way of studying financial data and company activities for adoption by the management team.
Such analyzes are carried out in specially designed programs for this. In the process, quantitative calculations are made that are based on different indicators, and the data obtained is evaluated and compared with other organizations. Financial analysis includes:
- asset analysis;
- solvency of the organization;
- stability in the market of goods and services.
With its help, such a moment as bankruptcy can be revealed. They are used by banks to issue a loan or by the chief accountant when reporting.
All financial analyzes are based on ratios. Among them are:
1. The relationship between capital and assets of the organization.
2. The ratio of assets that are in circulation to liabilities at a certain point in time.
3. The level of profitability of owned capital.
4. The level of profitability as a result of the sale of goods and services.
To obtain all the necessary information that is required for the analysis, in most cases they use the data of their accountants' reports. If you need to do a deeper and more detailed calculation of indicators, then data from financial indicators are involved. To search for a point that will break even, use accounting data and production accounting.
Project analysis
Break-even analysis of a project is an important element in evaluating project performance. The investor should have information about when the production will be break-even and how much needs to be made for this product. For the calculations use periodic, mandatory and total costs. Due to the constant increase in prices on which the cost of rent, utilities and other things depend, it is generally accepted that there can be no fixed costs. Therefore, for different time frames, the analysis should be repeated. Break-even analysis of products is performed for only one product name. If the workshop produces several types of goods, then the calculation of indicators should be individual for each case. It is worth taking into account the fact that even if the data obtained satisfy all the preferences and wishes of the investor, it is rather difficult to decide on the basis of this whether the project will be effective or not. What tasks are pursued in the analysis process?
Evaluation of the analysis of profit and break-even is performed only if a small period is taken. Also, for this, certain conditions must be observed and the production of the organization must exist with limited capacity. In other words, the organization should not expand during this period, install new equipment for work, open additional production facilities and offices.
In such cases, conducting breakeven analysis, you can solve a number of tasks, for example:
- find a point that will subsequently break even for the organization;
- identify how much finished products should be produced for further sale, so that this point is reached;
- what value should be set for goods and services in order to increase demand and generate the desired income;
- what production technology should be chosen to increase the level of efficiency;
- the opportunity is given to formulate a production plan that will be optimal.
Thus, the calculation of the break-even analysis in the organization is considered one of the options for studying the demand for goods and services in the current economic situation in the country.
Under what conditions should the analysis be carried out?
To conduct a qualitative analysis of the breakeven point, certain conditions and relationships must be observed. They are as follows:
- profit from sales and the amount of periodic costs completely depend on the capabilities of the enterprise;
- the level of performance should remain unchanged;
- in the period when the analysis is carried out, no changes in the prices of finished products and purchased material should take place in production and in the organization;
- the whole structure of the output does not change;
- it is necessary to accurately determine the amount of mandatory and recurring costs;
- by the time the analysis is completed, the company should not have any resources for further production, or they should be in a minimal amount.
If in the process one of the points is not observed, then it is very likely to get an erroneous result. If you stick to the basics of breakeven analysis, you can do everything right.
What does this mean for companies?
The search for a break-even point is only used if the planning is short-term. If there is a search for this point, then this does not mean that the organization plans to carry out its activities to zero, without generating income. In most cases, the break-even point is sought only in order to visually see the lower bar for the sale of finished products.
After this point is calculated, you can get a uniform balance between the amount of income and all costs. After this, you can have a clear idea of how many more units of goods to produce to obtain the desired profit. If everything is done without errors, then we can highlight the main factors that help in achieving the goals. Thus, the break-even point helps the organization to develop and receive income from doing business.
Every businessman or person far from financial matters understands that break-even is the key to the success of an enterprise. An organization that does not make a profit simply cannot exist, and analysis is simply necessary to obtain it.