The BIG Picture: Break-even Analysis

Feb 13, 2014

Break-even analysis can be and certainly is used characteristically to do just that, determine the break-even point for a business. This is usually looked at in a total fashion, something like I need to have $150,000 in sales each month to break-even. It is usually pretty straight forward and is easy to understand which is why many business owners apply such thought process. It also can be a very valuable analytical tool, meaning, if you do not believe you will have those kinds of sales in the coming month, you can take action to try to increase your sales and/or decrease your costs. If you do not know your break-even point and you go into the month blind, you cannot be proactive, only reactive, which after many months of being below break-even you may be in a situation in which it will be difficult to recover.

A more non-traditional application for a break-even point is using the calculation to help determine if an additional capital expenditure is worthwhile. You may be thinking of purchasing a new piece of equipment which is typically a larger investment than your everyday expenses. As a result, this requires more methodical decision making techniques to determine its benefit, it any. Break-even can be one of those techniques. Typically the reason for purchasing a new piece of equipment is to reduce your variable costs.  However, it will increase your fixed costs, such as interest and depreciation. I the decrease in variable costs is not more than the extra in fixed costs, it most likely is not a viable investment. Your break-even point should go down with a new piece of equipment!

There are some important things that need to be known in order to do this calculation! You need to know what the fixed costs for this piece of equipment are going to be, what the new variable costs will be, and of course, what the sales associated with it will be. 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, and will be supplying you with averages that you may be on the low end or high end of. 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 good general ledger numbers you are using to compare and understand the changes this new equipment will present. Also do not get hung up at only looking at one side, like just the expense side, but also at the big picture. Break-even analysis is that big picture.

Categories: Cost Accounting