Understanding Breakeven Analysis

breakeven analysis

Breakeven analysis is extremely important for appropriately assessing financial stability. Break even analysis provides management with the answer every owner wants to know: how much do we need to sell in order to stay in business? This invaluable analysis can be done with simple formulas, but if expenses are not properly recorded and accounted for, breakeven analysis will produce answers that are not only wrong, but dangerously misleading. This is where TGG shines. We will be able to provide your business with the accounting tools necessary for accurate forecasting.

The breakeven point is reached when sales equals the sum of variable and fixed costs. Breakeven analysis can be done in terms of both dollars and units. In other words, the breakeven point can be determined in the total number of widgets needing to be sold to stay afloat. The standard formula for determining breakeven in units is fairly simple, but requires an accounting system that can be relied upon for accurate costing. The magical breakeven point can also be determined in sales dollars, which is the easier method to both apply and understand if your business has multiple types of products.

Breakeven point in units = (Total Fixed Costs) / (Contribution Margin Per Unit)

Breakeven point in units = (Total Fixed Costs) / (Contribution margin Ratio)

Most business owners don’t want to “just breakeven” every month, they desire an amount of sales that will provide a slight “cushion” to carry them through a rough month. The “cushion” is known as the margin of safety. The margin of safety is simply the excess sales over the breakeven value. The margin can be determined in either dollars or as a percentage.

Total sales (in dollars) – Breakeven sales (in dollars) = Margin of safety (in dollars).

Margin of Safety as a Percentage = (Margin of safety in dollars) / (Total Sales)

When analyzing breakeven values, there are numerous other factors to consider, such as the margin of safety (described above) which allows your business to carry itself through a “rough month.” Other factors include tax implications, predicting profit performance, and setting sales prices based on the assumed volume of production. Each of these calculations will “hone” in your knowledge of where your business stands, where it needs to be, and how to get there. TGG is happy to help answer each of these questions, and looks forward to helping you grow your business to its full potential.

Written by:
Jake Cavanagh
TGG Accounting
 
 
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