Of course, every business wants to make a profit, but an interesting exercise to undertake is a Break Even Point (BEP) analysis. A Break Even Point analysis takes into account all of the costs involved in creating a product or service and determining at what point the product or service will break even, and when it will begin to show a profit. This is an extremely useful exercise to do when you are deciding on a product or service to sell, and give you an idea what level you must sell in order to be profitable.
If you would like an illustration to follow, you can find a spreadsheet on my LinkedIn Profile. This is a working spreadsheet, so you will be able to adapt it to fit your needs. I would also point out that this is a simplified BEP model in order to explain the concept; many BEP analyses are quite complex.
A Break Even Analysis will be based on certain assumptions, and then perform calculations based on those assumptions. The following variable s is contained in this model:
Units Sold: The number of units (hours, etc) that will be sold.
Cost per Unit: The actual makeup of this variable can depend. In some cases, it may contain direct and indirect costs and perhaps overhead. For the purpose of this model, it contains direct costs only.
Variable Costs: A simple calculation of Units Sold X Cost per Unit. Remember that Variable Costs rise in direct proportion to the Units sold.
Fixed Cost: Fixed Cost remains the same no matter how many units are sold. Fixed Cost may include rent, electricity and other costs that remain the same. Please note that depending on the situation, some Fixed Costs may be included in Cost per Unit. For the sake of simplicity, we are keeping Fixed Cost Separately.
One of the keys to a Break Even Point analysis is understanding how Fixed Cost effects overall profitability. Cost per Unit does not change for each unit, it is always the same. Fixed cost must be spread over the number of units produced. The fewer produced the greater portion of Fixed Cost that is assigned to each unit sold.
Retail: The selling price of a unit.
BEP Costs: A calculation of Fixed Cost + Variable Cost that determines the entire cost of X number of units to be sold.
Total Revenues: Again a simple calculation, Units Sold X Retail.
Contribution Margin: The difference between Total Revenues and BEP Costs,
Total Revenues – BEP Costs.
CM Ratio: (Contribution Margin Ratio): Contribution Margin/Total Revenues
Below is an example of a BEP Analysis: As you can see, 333 units sold is the Break Even Point; therefore in this case, if you cannot forecast a sale of at least 333 units, you would not want to move ahead with production of the unit. As you can see, Break Even Point Analysis is a very useful addition to any business’ tool kit.
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