|Financial Information - Break-Even Analysis
Another useful tool that will help you to measure your business performance at the outset is the break-even analysis. You can measure your break-even point in level of sales in either dollars or units where revenue equals total cost.
The break-even analysis is especially useful when you're developing a pricing strategy, either as part of a marketing plan or a business plan.
Break-even analysis depends on the following variables:
- Selling price per unit: The amount of money charged to the customer for each unit of product or service.
- Total fixed costs: The sum of all costs required to produce the first unit of a product. This amount does not vary as production increases or decreases, until new capital expenditures are needed.
- Variable unit cost: Costs that vary directly with the production of one additional unit.
- Total variable cost: The product of expected unit sales and variable unit cost, i.e. expected unit sales times the variable cost.
Each of these variables is interdependent on the break-even point analysis. If any of the variables changes, the results may change.
Total Cost: The sum of the fixed cost and total variable cost for any given level of production, i.e., fixed cost plus total variable cost.
Total Revenue: The product of forecasted unit sales and unit price, i.e., forecasted unit sales times unit price.
Break-Even Point: Number of units that must be sold in order to produce a profit of zero (but will recover all associated costs). In other words, the break-even point is the point at which your product stops costing you money to produce and sell, and starts to generate a profit for your company.
As a business owner you can play with the variables to make managerial decisions like:
- setting price level and its sensitivity;
- targeting the "best" values for the variable and fixed cost combinations; and,
- determining the financial attractiveness of different strategic options for your company
Q = FC / (UP — VC)
Q = Break-even Point, i.e., Units of production (Q),
FC = Fixed Costs
VC = Variable Costs per Unit
UP = Unit Price
Break-Even Point Q = Fixed Cost / (Unit Price — Variable Unit Cost)