The Break-Even
Point and
the Break-Even Margin
by Jack Deal
The break-even point is defined
as the point where sales or revenues equal expenses. There is no profit
made or loss incurred at the break-even point. This figure is important
for anyone that manages a business since the break-even point is the lower
limit of profit when setting prices and determining margins. Obviously the
break-even point becomes very important when calculating a strategy for
net profit.
The break-even margin is a ratio
that shows the gross-margin factor for a break-even condition. The formula
is total expenses divided by net revenues multiplied by 100 to get a
percentage. This ratio is helpful when setting prices, with competitive
bidding and when negotiating contracts with vendors and accounts.
The dynamics of the break-even
point and the break-even margin show managers the impact of their
decisions. In purchasing, costs can be lowered by bulk purchasing,
negotiating price/ terms or finding new suppliers. Revenues can be
improved by increasing value to the customer or offering non-price
concessions. It must be remembered that increasing profits by simply
increasing margins is a risky strategy. Unless the consumer perceives
higher value, increased prices may negatively impact sales. The customer
ultimately decides benefit, value and sales.
When looking at break-evens it is
also helpful to look at fixed and variable costs. Fixed overhead is steady
and can be factored in quite accurately. Variable costs are not as simple
to calculate but in many industries variable costs follow certain
percentages or ratios so they are easier to project.
It is also helpful to look at
break-evens on a daily, weekly, monthly and yearly basis. Many
construction companies base their bids on when they hit their yearly
break-even. Once that point is reached they can make their bidding more
competitive to stay busy and profitable.
I have found if very useful to
let personnel know the break-even figures. This gives them a very clear
picture of expenses and what it actually takes to run the business.
Sharing break-even figures also reduces the perception that ownership is
getting rich off of the employees’ efforts.
If you do not know your
break-even point ask your accountant to show you. Some bookkeepers are
able to add the break-even point to their reports. If you think finding
out the obvious is not worth the effort, just consider how many businesses
have failed because they did not
know their break-even point.
Jack D. Deal is owner of Deal Consulting 831-457-8806. Related articles
may be found at www.dealconsulting.com. |
