Break Even Analysis
In business planning, asking the proper questions and obtaining answers to those questions is arguably the most important thing. Questions such as; how much do we have to sell to reach our profit goal? How much do our sales need to increase in order to cover a planned increase in advertising costs? What price should we charge to cover our costs and allow for the planned profit goals? Is our business going to be profitable? Answers to such difficult questions become accessible with the utilization of the break even analysis. Break even analysis can be conceived arguably as one of the simplest tools in accounting; however, its simplicity does not take away from its importance.
Break even analysis is used in cost and managerial accounting along with capital budgeting to evaluate projects or product lines in terms of their volume and profitability relationship. Essentially it helps business owners to understand how much product they have to sell to cover all expenses. Total expenses consist of two cost components; fixed and variable costs. Fixed costs are the expense items which generally do not change from month to month, regardless of how much you sell, use, or produce. On the flip side, variable costs are those expenses that change with the unit level of either production or sales. Such expenses normally increase with increased production because such expenses are directly involved in making the product or making the sale. The most basic formula for break even analysis is total fixed costs divided by the average price per unit minus variable costs per unit. In mathematical terms, it is simply the point where total expenses equal to net sales revenue. A key component of break-even analysis is the contribution margin, which is the product or service's price minus variable costs per unit sold part of the equation. The contribution margin concept is grounded in marginal analysis; its focus is the extra revenue and costs that will...
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