Dec 12, 2016
Break-even analysis is used to determine the break-even point for a business. This is where the total revenues equals total expenses. In other words, the break-even point is where a company produces the same amount of revenues as expenses either during a manufacturing process or an accounting period. Such analysis can be a very valuable analytical tool to determine if action must be taken to increase sales or decrease your costs. Some business owners do not know their break-even point and instead enter each month blindly. This can be extremely dangerous as you are unable to be proactive, only reactive. Leading a business down such a road may result in an inability to recover and ultimately the failure of a business.
A more non-traditional application for a break-even point is using the calculation to help determine if an additional capital expenditure is worthwhile. If you are considering making a large investment by purchasing a new piece of equipment you will require a more methodical decision-making technique to determine benefit. Break-even analysis can be one of those techniques. Purchasing a new piece of equipment may reduce your variable costs. However, it will increase your fixed costs, such as interest and depreciation. If the decrease in variable costs is not more than the extra in fixed costs, it is not a viable investment. In theory, your break-even point should be reduced with the purchase of new equipment.
There are some important considerations to be made when calculating your business's break event point for a new piece of equipment. You must know what the fixed costs will be for the equipment, the new variable costs, and the associated sales. These are all the necessary parts of a break-even analysis. It all seems simple enough, but if you are looking to purchase this machine, you do not yet have it to know these things for certain. It is important to do as much research and have as much valuable information as possible. Keep in mind, the dealership selling the equipment wants to make a sale and may inflate some of the positive numbers. This may mean you will be working with averages which may be on the low end or high end. Nevertheless, this can be a very valuable tool in determining if it is a viable option. If your sales will have to be so high to cover the costs of a new machine, then it may not be worth it.
Like all calculations, it is vital to have quality and accurate general ledger numbers to compare and understand. Do not review the implications of a purchase from one side - the expense side. Instead, make sure you consider the overall impact. Break-even analysis is your big picture view.
By: Tara West, CPA, CMA