Break-even analysis is a financial tool used by finance and investment professionals in determining when the business can reach a point of zero loss or gain. The break-even point is the point of required business volume so that the company can pay for all its costs. Mostly break-even analysis in excel is used for identifying the relationship between revenues, fixed costs, and variable costs. Having low fixed costs (costs that are not affected by the increase in the quantity of production) also leads to a low break-even point and therefore minimizes the risk of running into losses.
What is the Definition of Break-Even? The break-even point is the point where revenues equal all costs. Break-even analysis in Excel takes a good look at the cost structure. In essence, costs such as material, labor, rent, marketing, sales, IT costs, general & administration, and analyzes how each cost block will react when increasing/decreasing the business volume and what the effect on profits will be. The definition of Break-Even is where total costs equal revenues, ergo profits are zero. There are different ways of computing for the break-even point, but we will discuss the two most common approaches. The first one is based on the number of units sold, and and the second approach is based on sales dollars. Break-even Calculation for Required Number of Units To determine the break-even point based on units, divide the fixed costs by the contribution margin. The contribution margin is computed by subtracting the variable cost per unit from revenue per unit. Fixed costs are the costs that remain the same despite the change in the volume of production. Variable costs are the costs that are dependent on the increase/decrease in production such as raw materials, packaging, and labor. To better understand the computation, please find the formula below: Break-Even Units = Fixed Costs ÷ Contribution Margin per Unit Let's say the cost for materials and labor is $120; your contribution margin is $2/unit, you will need to sell 40 units to achieve break-even (Profit = 40 x $2 Contribution Margin - $80 Fixed costs). Break-Even Calculation for Sales Dollars In computing for the break-even point based on sales dollars, we divide the fixed costs by the contribution margin profit ratio (as % of revenues). Let's take a look at the formula below: ▪ Break-Even Sales Dollars = Fixed Costs / Contribution Margin % of Revenues ▪ Contribution Margin Ratio= $ Contribution Margin / $ Revenues (based on observable results) Example: - Fixed Costs = $100 - Contribution Margin = 20% of Sales Break-Even Sales Dollars = $100 / 20% Contribution Margin % of Revenues = $500 This means we require $500 in revenues in order to achieve break-even. Conclusion: Reduced Risk and Optimized Pricing are the Benefits of Break-Even Analysis Break-even analysis helps with the following: ▪ Business Risk - Break-even analysis helps to assess the impact if there is a sales downturn in the business. By identifying high fixed costs and seeking ways to transform those fixed costs into variable costs, business risk can be reduced. Therefore, break-even analysis can help you in the overall financial decision making when it comes to how to build your business model. ▪ Pricing Strategy – Break-even analysis can give you a second opinion in terms of the pricing of your products. Your goal should be to achieve break-even within a short period of time by avoiding long periods of losses. You can best identify if your prices are too low when it is impossible to reach break-even within a short time frame. Break-even analysis helps to optimize the pricing strategy. ▪ Capacity Utilization – break-even analysis also can be beneficial to identify untapped production capacities and leads to the right questions on how to utilize production capacities better. ▪ Production Automation – Break-even analysis can help you to assess the impact of changing from manual production to automated production processes. Therefore, it can offer a valid argument that by spending money on automation equipment, the break-even point can be reduced. ▪ New Products: By adding a new product, you may also need to consider the added costs and incorporate them into the pricing of the new product. ▪ Changes in Prices and Costs: Break-even analysis helps to assess the impact of in prices and costs on profit. To conclude, break even analysis in Excel is a must tool to use when determining the viability and targets for your business as it helps to assess the risk and identify the strategies of how to mitigate such risk. Conducting break-even analysis regularly will add to your confidence in making financial decisions for your business as you move forward.
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It is now the era where time and money run the world, thus, efficient and resourcefulness are two traits that are highly sought after in every task nowadays. That’s why the emergence of tools to help running a business became a critical factor to financial success. One of these tools is what we call a financial model.
Financial modeling typically entails the process of building an abstract representation of a business’ financial situation. It comes in a model form specifically designed to represent a numerical report version of the performance of a business, project, or any other investment. It is a skill that is highly valued and yet very hard to master as it will take a lot of experience and a substantial know-how about different industries. In simpler terms, financial modeling in Excel is the task of building a financial model. However, financial modeling in Excel is not as easy as it sounds. You will need a lot of time to hone your skills as well as practice to produce good quality financial model that works according to its purpose. But of course, not everyone has the time to spend learning or building a financial model from scratch. Therefore, the demand for ready-made financial model templates in Excel is high. By using such templates, building a financial model became an easier task and will also cost you less compared to hiring a professional to create a model from the scratch and will serve as a base to start with your model and you’ll only have to fill up the figures accordingly and then adjust the model according to your preference. Since the financial modeling examples are usually in Excel, the model is flexible enough for you to customize and update, also at the same time you will have full transparency about how things are calculated and came up to be. If you are running a business and looking for a platform where you can acquire or download industry-specific or general use financial model templates for different use cases, you can simply visit eFinancialModels. eFinancialModels is a platform providing a wide range of industry-specific Financial Model Templates made by financial modeling experts with a vast experience in financial modeling and substantial industry know-how. Feel free to read more about Financial Modeling in Excel to learn more about the significance of building a financial model, how to build a financial model, as well as what to avoid when building a financial model with this article: Financial Modeling in Excel – Significance, How To’s, and What to avoid. |
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January 2021
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