Focusing on the revenue of a company, how do you think a breakeven analysis will assist with providing detailed financials?
A break-even analysis measures the level of sales a company must reach in order to cover their initial investment, giving executives the data they need to assess whether important financials like budgets, sales forecasts, and ROI projections are viable or whether they need to be revised. It also reveals at what level the entire enterprise becomes unprofitable.
A break-even analysis is an important component of a company's financials because it articulates the level of sales a given product or service must reach in order to cover the initial outlay in that product or service. Moreover, it measures the margin of safety in a given transaction, which is the spread between the estimated sales and actual sales, which allows management to assess how far sales may decrease from current levels before the thing being sold is unprofitable.
A break-even analysis will reveal the product or service's break-even point (BPE), where expenses equal revenues. It's calculated by taking the total fixed costs and dividing it by the sales price per unit less any variable costs per unit. (The difference between the unit sales price and variable costs is called the contribution margin.) So, for example:
If fixed costs = $1,500 total, variable costs = $3 per unit, and the sale price is $5 per unit, then the break-even point is $1,500 / ($5 - $3) = 750.
Therefore, the company must sell 750 units with these costs at this price point in order to break even.
Such an analysis forces company executives to really analyze the strength and accuracy of their financial records, including sales projections and revenue forecasts, fixed and variable cost budgets, profit margin targets, and estimated ROI (return on investment) scenarios. Done properly, it will reveal whether these financials are realistic or need to be revisited.
Break-even analyses are conducted solely for the benefit of corporate management so that they can make decisions that will affect their bottom-line profits and the overall financial health of their company. It's not intended for outsiders, like third-party investors.
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