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Breakeven Analysis – what does this really mean?

 

In simple terms your breakeven is the absolute minimum sales you need to achieve before you start running at a loss. In other words, it is the value of sales that will give you neither a profit nor a loss.

 

It is a simple concept but it is very valuable to know what this figure is, as you can then track your sales and be forewarned about the possibility of making a loss, rather than only finding this out after the month end, or later, when you draw up your income statement. Or worse still when your accountant draws it up a few months later.

 

You can find a template on the website to help calculate the breakeven and it is basically a simple calculation. It is the sales less the variable (or direct) cost of those sales that will cover all your fixed expenses.

 

Example

 

You sell your product for R50.00 each with a gross profit of R10.00 per each item and your overheads or fixed expenses are R10 000.00 per month. In order to cover those overheads or fixed expenses you will need to sell 1000 units per month; calculated as follows: R10 000.00 (overheads) / (divided) by R10.00 (gross profit) = 1000 units.

 

There are, however, potential pitfalls to be aware of when calculating your breakeven.

 

  1. Your gross profit % may vary month by month due to discounts or product mix (if you sell different products with different gross profits.

 

  1. Not all expense are either directly variable or absolutely fixed. For example distribution expenses as a % of sales may fall as sales increase, wages may rise over a certain level of sales as more staff are required or telephone and computer costs may be different at different levels of sales.

 

You will need to be aware of how each cost changes as sales change. As costs do not normally change significantly as sales change within a narrow range the breakeven you calculate will be reasonably accurate. If you are working on a major change in sales you will need to reassess your breakeven.

 

  1. For the reasons above do not treat the breakeven figure as absolutely correct but rather as a guide to measure and track.

 

If you are not in a position to get a monthly income statement, knowing your breakeven will give you a very good idea of how well your business is running and a good estimate of what your profitability is.

 

By | 2018-02-20T07:11:37+00:00 August 8th, 2016|Articles, Financial|0 Comments

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