. Give an explanation of break-even analysis and explain how it supports the achievement of strategic aims and objectives.
Break-even analysis compares a firm's revenue with its fixed and variable costs to identify the minimum sales level needed to make a profit.
The starting point for all financial management is to know how much goods or services cost to produce. If a business knows how many products they have to sell, they can benefit from it because this can cover their costs.
This is particularly important for new businesses with limited experience of their products or their markets. It is also of value for established businesses which are planning to produce a new product.
A company whose aims and objectives are growth, continuity, investment, innovation etc can use break-even analysis as a cheap, quick and simple tool to analyse and estimate the future level of output they will need to produce and sell in order to meet given objectives in terms of profits.
It can also help to assess the impact of planned price, changes upon profit and the level of output needed to break-even.
It is also of value for established businesses which are planning to produce a new product. It also helps to support applications for loans from banks and offer financial institutions-the use of the technique may indicate good business sense as well as forecast profitability, and therefore businesses would be able to get financial help to support and meet any of their business objectives.
Break-even analysis can also be calculated, this requires:
* The selling price of the product.
* The fixed costs.
* The variable costs per unit.
The formula for calculating the break-even output level is:
Selling price per unit-variable cost per unit.
To calculate the 'break-even point' we need information on both: costs and prices. A change in costs or in the firm's pricing policy will change the level of output at which the firms break-even.
Break-even analysis is simple to understand and useful-especially in small firms. Businesses can use break-even to:
* Estimate the future level of output they will need to produce and sell in order to meet given objectives in terms of profit.
* Assess the impact of planned prices, changes upon profit and the level of output needed to break-even.
* Assess how changes in fixed and/or variable costs may affect profits, and the level of output necessary to break-even.
* Take decisions on whether to produce their own products or whether to purchase from external sources.