subject: It's The Age Old Question, How Many Of "these" Do I Have To Sell Before I Make Any Money? [print this page] Break even analysis is a widely used technique that production management and management accountants apply to categorize production costs among variable and fixed costs. Variable costs, as the name implies, are those costs that change with changes in production volumes while fixed costs are not in any way affected by changes in the volume of production. When the fixed and variable costs are compared with sales revenue it becomes possible for determining the volume of sales and value of sales or production at which the business neither earns a profit nor incurs losses and this is known as "break even point".
To graphically represent production costs, a break even chart is used to show costs at different levels of activity along with the revenue or income from sales within the same level of activity. When the two lines (cost and revenue) intersect and where there is neither profit nor loss, that point on the chart is called the break even point.
Fixed costs, as mentioned earlier, are those costs which the business will incur regardless of the level of production and are incurred even if the business has zero level of production. But, in the long term these fixed costs may get altered due to changed circumstances such as more investment in production capacity like adding a new factory unit or when overheads grow due to larger and more complex business needs. Some examples of fixed costs are rent and rates, depreciation, research and development, marketing costs that are not related to revenue, and costs of administration.
When costs change with different levels of production these costs are referred to as variable costs and they include paying for inputs such as raw materials, direct labor, fuel and other income related costs such as commissions paid. In addition, the variable costs are classified into direct and indirect variable costs.
It thus becomes imperative for a business to know whether it will be profitable or not. This is where the break even analysis comes in as it will inform you of how much revenue is needed to cover expenses, before making any profit. In case the business can meet or surpass the break even point it will mean that the business stands a good chance of earning revenue.
Numerous business people use the break even analysis as a means to screen and evaluate new business ventures. A business plan is only drafted if it has been shown by the break even analysis as being viable. A break even analysis may start off by establishing all fixed costs that need to be covered by the expected revenues of the company. There are three ways of lowering your break even volumes and these are lowering direct costs to cause an increase in the gross margin, exercising cost controls on fixed costs and finally, raising prices. Since the primary aim of a business is to earn a profit and not just break even, knowing what the break even point is, will help to allocate sales and marketing efforts to achieve the break even point, knowing the elements of a break even point facilitates managing costs and thus can capitalize on the bottom line.
by: Wade Anderson
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