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Benefits of break even analysis

The main Benefits of break even analysis is that it explains the relationship between cost, production volume and returns. It can be extended to show how changes in fixed cost-variable cost relationships, in commodity prices, or in revenues, will affect profit levels and break-even points. Break even analysis is most useful when used with partial budgeting or capital budgeting techniques. The major Benefits of break even analysis is that it indicates the lowest amount of business activity necessary to prevent losses.

Break even analysis enables a business organization to:
  1. Measure profit and loses at different levels of production and sales.
  2. To analysis the relationship between fixed cost and variable cost. Break-even analysis is widely used by production management and management accountants. It is based on categorising production costs between those which are variable (costs that change when the production output changes) and those that are fixed (costs not directly related to the volume of production).
  3. To predict the effect of changes in price of sales.
  4. To predict the effect on profitablilty if changes in cost and efficiency.
  5. This is extensively used by production and accountants' management. It is based on categorizing production costs between those which costs change when the production output changes and those that are fixed, costs that are not directly related to the volume of production.

You still have to compare the demand figure at break even with the market share you think you can capture to judge the worthiness of the project, and you'll have to use your business sense here. But break even gives you a way to attack uncertainty, to get onto the target if not the bull's-eye.

It serves as a substitute for estimating an unknown factor in making project decisions. In deciding whether to go ahead or to skip it, there are always variables to be considered: demand, costs, price, and miscellaneous factors. When most expenses can be determined, only two missing variables remain profit (or cash flow) and demand. Demand is usually tougher to estimate. By deciding that profit must at least be zero, (the break even point), you can then fairly simply find the demand you must have to make the project a reasonable undertaking.

Limitations of break even analysis

Even though break even is a very useful risk assessment technique and a useful device for testing the sensitivities of business performance, there are also several demerits of break even analysis, though it has the above advantages or uses. The following limitations of break even analysis must be considered:
  1. Assumes that sales prices are constant at all levels of output. It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. (i.e. linearity)
  2. Assumes production and sales are the same.
  3. Break even charts may be time consuming to prepare.
  4. It can only apply to a single product or single mix of products.
  5. Break even analysis is only a supply side (i.e. costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices.
  6. It assumes that fixed costs (FC) are constant. Although this is true in the short run, an increase in the scale of production is likely to cause fixed costs to rise.
  7. It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period).
  8. In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant (i.e., the sales mix is constant). It is best suited to the analysis of one product at a time;
  9. It may be difficult to classify a cost as all variable or all fixed; and
  10. There may be a tendency to continue to use a break even analysis after the cost and income functions have changed.

Business strategies definition


Business strategy development

  1. Idea generation
    1. Opportunity analysis
      The strategy of assessing the potential for a change or enhancement to enhance the generation of revenue.
  2. Idea screening
  3. Business analysis
    1. Break even analysis
    2. Benefits of break even analysis
    3. Fourt Woodlock equation
      The tool used to determine whether the product idea will be profitable or not.
  4. Critical path analysis
  5. How to make critical path analysis?
  6. Critical path in business
  7. Logistics strategic plan
    Logistics is how to get raw materials, move them in the system, distribute and replace them.
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