Break-even analysis calculates the amount of revenue needed to cover all costs of operating a business. It includes identifying all expenses, comparing total costs to total sales, and using the analysis to forecast projections and make adjustments.
A break-even analysis is a valuable calculation that is useful for both large and small business accounting. Essentially, break-even analysis is a process that allows an entity to determine the amount of revenue generated that must be produced to cover all costs of operating the business. Performing a periodic break-even analysis helps a company position itself so that the business is competitive, is capable of reaching a point where the company is profitable, and also helps the business prepare for expansion.
The elements that go into an equilibrium analysis are very simple. The first step is to identify and account for all expenses associated with the business enterprise. This will include fixed costs and variable costs. For the purposes of arriving at the equilibrium analysis, taxes are certainly taken into account. Factors such as the cost of raw materials, labor, labor management, plant and machinery operations, sales, marketing, and packaging all go into the calculation. Even costs like electricity and other utilities that are needed to operate the facility are considered costs associated with the general operation of the business.
The total cost of operation is compared to the total amount of sales that result as part of the effort. By breaking down sales into unit price increments, it is possible to determine how many individual units of the goods or services offered by the company must be sold in a given period to cover production costs for that same period. The hope is that the break-even analysis will show that the company is selling enough units to not only cover all expenses, but also enough additional units to generate a net profit for the corporation.
Performing a break-even analysis is also useful for several other reasons. The analysis can be used as a tool to forecast overall projections for upcoming periods. Adjustments may be made to the operation or production in response to the findings of the analysis. In the case of a potential new product launch, break-even analysis can use historical data to determine how many units of the new product will need to be sold to maintain the current level of profitability. In general, breakeven analysis can use past data as an important calculator of what might happen in the future.
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