Break Even Point
A break-even analysis is a type of financial computation that compares the cost of starting a new business venture against the unit sell price to determine when the organization will break even. In other words, it is an indication of the point at which the company would have sold enough unites to recover all of the costs that have been encountered in the production process (Hanggraeni et al., 2019). Therefore, the company would have only recovered the principal amount put into the business at the point of breaking even. Any point below that of break-even means that the company was operating at a loss. After the point, any sales activities made by the organization will start to yield the needed profits (Wolmarans and Meintjes, 2015). So, the management will take advantage of break-even analysis whenever they want to consider adding cost. A key factor to consider is that break-even does not account for demand.
| Performance Report For month ending June 20xx | ||||||||
| I | II | III | IV | V | ||||
| Static Budget | Actual | Variance (II–I) | Favorable (F) or Unfavorable (U) | Flexible Budget | Variance (II–IV) | Favorable (F) or Unfavorable (U) | ||
| Manufacturing Overhead Costs | ||||||||
| Indirect Labor | $ 125,500.00 | $ 150,600.00 | $ 25,100.00 | U | $ 100,400.00 | $ 50,200.00 | U | |
| Supplies | $ 225,000.00 | $ 289,750.00 | $ 64,750.00 | U | $ 160,250.00 | $ 129,500.00 | U | |
| Utilities | $ 119,000.00 | $ 182,500.00 | $ 63,500.00 | U | $ 55,500.00 | $ 127,000.00 | U | |
| Total | $ 469,500.00 | $ 622,850.00 | $ 153,350.00 | U | $ 316,150.00 | $ 306,700.00 | U | |
The formula for obtaining break-even considers both the fixed and variable costs. Fixed costs represent those that will remain the same despite the number of products that have been sold. The value is obtained from the actual budget. For the organization, the value of fixed costs is $622 850. It incorporates indirect labor, supplies, and utilities. Variable costs can change based on the number of sales that have been made. The value is obtained from the static budget, which can change in the future. For the company, the value of the variable costs is $469,500. The selling price is another factor to consider while evaluating the break-even point for an organization. The company intends to venture into the production of Ottoman as the new product. From the plan, the selling price for the Ottoman stands at $55,000. The selling price and variable costs are expressed for a product unit under manufacturing. The outcome of the break-even analysis indicates that the company will need to sell 208,350 of the Ottoman products so that it can start generating profits. Equally, the sales at the break-even point stand at $11,459,250,000. The feasibility of the operation is not favorable since the sales are to be made much higher, implying that it will take much longer for the company to be able to break even.
| Break Even Analysis | ||
| Selling Price | $ 55,000.00 | |
| Variable Costs | $ 469,500.00 | |
| Fixed Costs | $ 622,850.00 | |
| Break-even Quantity | $ 208,350.00 | |
| Total Sales at Break Even | $ 11,459,250,000.00 | |
Strategies for Profitability
The first strategy that the organization can consider to increase the profitability of manufacturing Ottoman is to increase the average contribution margin for the products that they want to display for sale. It will be possible to effectively and efficiently work on the variable costs by reducing their value in the process. Another design to consider is to redesign the Ottoman products they intend to manufacture. The approach will play a key role in reducing the cost used in the production process while increasing the sales that will be made (Gallo, 2014). A rise in sales and an increase in the price for the commodity implies that more profits will be generated at the end. The second strategy that the corporation can consider is increasing the price level for the Ottoman. However, the reliability of the design will only take place if the consumers of the products are not sensitive to changes in price. If that’s the case, there will be issues since the client will consider buying the same products from a different place, reducing the net sales, and it will be impossible to focus on profitability and the end goals. So, increasing the prices will be the most suitable option when the organization is perceived to be a high-quality provider or the commodity will be highly branded.
In summary, the organization can consider two approaches that will effectively lower their break-even. One is to lower the cost and the second strategy is to increase their prices. A decline in the break-even point means that the company will generate profits earlier than anticipated (Nuril, 2017). However, the positive outcomes will only be felt if all the other factors affecting the operations are constant. For instance, a factor like demand is being assumed since raising the prices of the commodities might unexpectedly affect the company.
Impact on Managerial Decision
A better understanding of the break-even analysis will be crucial in managerial decision-making because it will be easy to know the instances where it can be applied. For instance, the company manager will know that expanding the venture, lowering prices, and narrowing the enterprise will require a break-even analysis (Likierman, 2020). The outcomes aim to give the owners a reality check of the period that their investment will take to start generating profits. For example, a computation of the modeling minimum sales will need to consider the costs likely to be encountered in the new location or while venturing into a different market.
There are business ventures that need to lower the prices of their commodities to beat the competition in specific segments of the market. Therefore, while lowering the prices, a break-even analysis will allow the manager to consider the various business needs required and some of the operations that will be affected. It will be easy to create a contingency plan that can be implemented either now or later. The main focus will be on offsetting or making up for the decline in the profits (Cvetkoska, 2016). While changing the business activities, it is vital to use the break-even analysis approach to assist decision-making processes. Various scenarios arise mainly appertaining to what-ifs where there is uncertainty of the events which will take place in the future. Knowledge and skills on break-even approaches will provide clarity, making it easy to decide without dilemma. There will be a reduction of the decision-making process to simple yes or no questions.
The anticipated risks in the future will have been reduced, especially in situations where there is a need to add cost. From the evaluation of the break-even for the organization, it is evident that the variable and fixed costs are essential elements to consider in decision making. The primary outcome is to realize the duration of a shift from making losses, and the company starts generating good income.
References
Cvetkoska, V. (2016). A survey of the use of operational research in decisions made by micro, small and medium-sized enterprises in Macedonia. Croatian Operational Research Review, 349-365.
Gallo, A. (2014). A quick guide to breakeven analysis. Harvard Business Review.
Hanggraeni, D., Ślusarczyk, B., Sulung, L. A. K., & Subroto, A. (2019). The Impact of Internal, External and Enterprise Risk Management on the Performance of Micro, Small and Medium Enterprises. Sustainability, 11(7), 2172. DOI: https://doi.org/10.3390/su11072172\
Likierman, A. (2020). The elements of good judgment. Harvard Business Review.
Nuril, D. (2017). Application of Break Even Point (BEP) as a Profit Planning Tool. Thesis in Administrative Sciences. University of Jember.
Wolmarans, H. P., & Meintjes, Q. (2015). Financial management practices in successful Small and Medium Enterprises (SMEs). The southern African journal of entrepreneurship and small business management, 7(1), 88-116. DOI: https://doi.org/10.4102/sajesbm.v7i1.8
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