breakeven Flashcards
What does breakeven mean
A business will always want to know how many products (or services) they need to sell in order to cover their costs. This is normally the bare minimum a business will aim to achieve.
When a business is breaking even, there is no profit and no loss (revenue = total costs).
Breakeven formula
Break-even Output = Fixed Costs divided by the Contribution Per Unit.
Advantages of breakeven
Break-even provides a simple and easily understood representation of costs, revenue and potential profit.
Break-even is also useful as part of a business plan and can help when seeking a loan.
It also allows the use of ‘what-if’ analysis. Using ‘what-if’ analysis, business owners can judge the impact of a number of costs and revenue variables on profitability.
Disadvantages of breakeven
The use of ‘what-if’ does not fully overcome the weaknesses of break-even. The first problem is that the method assumes only one product is produced and sold; in the real world of business, this is rarely the case. This initial problem can be overcome if a business (e.g. a sandwich shop) sells a similar range of products as, in this case, an average cost and revenue per customer can be estimated.
The method also assumes that all goods are produced and sold at the same price. Most businesses have wastage through damaged stock, poor quality stock, etc., and it is likely that at least some products (end of line) will be discounted.
The linear relationship of costs/revenue to output/sales can also be questioned. In each case, economies of scale are likely to come into play, breaking down the relationship.
Some fixed costs are stepped. This occurs when a business acquires more capacity, whereby costs such as rent may increase. This sharp rise in fixed costs makes it difficult to apply break-even analysis.
