The Power of Break-Even Analysis

The Power of Break Even Analysis image Break Even Chart jnkxeaThe Power of Break Even Analysis photoAh, the lowly break-even analysis. Maybe you learned break even analysis in Accounting class, or Finance, or even Marketing class. So simple, so … pedestrian. But, you’re wrong. Break-even analysis is very powerful and should guide your marketing decisions. Do you use the power of break-even analysis to guide marketing decisions?

What is break-even analysis?

As you see in the image, break-even is the point at which you start making money. Up to break-even, you’re losing money — which is never a good thing, but unavoidable sometimes.

So, how do you do a break-even analysis?

First, gather all your costs.

Second, divide them into fixed costs and variable costs.

Fixed costs stay the same regardless of how much you sell. Items such as rent, utilities, administrative salaries, etc are generally considered fixed.

Variable costs vary with the amount of product you produce. Materials, labor, and transportation are common types of variable costs. Even service businesses incur variable costs for things like food for a restaurant, cleaning for hotel rooms, and inventory for a retailer.

Next, calculate your contribution margin — which is your selling price – variable costs

Finally, divide your fixed costs by your contribution margin. You now have your break-even point showing how many units (or $$$) you must sell to hit break-even.

Easy peasy. But, that’s NOT very powerful, you say. And, I agree. First off, who wants to just break-even. Secondly, how does knowing this help me make marketing decisions. Well, that’s the secret power of break-even analysis. You can now play games with your break-even to improve your ROI (return on investment).

Using break-even analysis for decision-making

Discovering how much you’ll make or lose this year

Well, obviously, you can use break-even analysis to discover how much money you’ll make or lose. And, if you’re losing money, you can use break-even analysis to help you make more money. Can you charge more for your products? Pay less for materials? These changes can ensure your make a profit.

This may sound simplistic, but I once consulted with a client who had no idea whether he was making money on his products. He was a manufacturer and just guessed at how much it cost to make each piece of his inventory and charged what he thought customers would spend. His profits were declining and we couldn’t even help figure out where the problem was without a major overhaul in his business record-keeping (activity-based costing is needed to figure out how much it costs to manufacture each product).

Play “what-if” games using break-even analysis

Termed sensitivity analysis, this form of break-even analysis allows you to estimate the financial impact of different business decisions. For instance, what happens if you spend $20,000 on advertising? Add $20,000 to your fixed costs and redo the break-even analysis and you now have a new amount of product you need to sell to break-even.

You can use break-even analysis to answer all kinds of questions that aid decision-making across a wide range of situations.

  1. Will your product hit a target ROI? — just add your minimum desired profit to your fixed costs and do a new break-even analysis
  2. Should you introduce a new product? Calculate the new break-even with the new product. Be sure to account for any cannibalization of existing brands.
  3. Is it better to offer a discount on your brand or pay a fixed amount for advertising? Just do a break-even analysis for each scenario and compare the outcomes.
  4. Would the decrease (increase) in product quality more than compensate for the lower (higher) cost of materials? Again, compare the 2 break-even analyses.
  5. Should you make a product from scratch or assemble it from purchased components? Do the break-even analysis twice.

See the power of the lowly break-even analysis? Remember, that the true power of break-even analysis relies on having good consumer data. Without accurate forecasts of how consumers will respond to proposed changes, you don’t know whether your new break-even point is attainable. And, without customer insights, it’s hard to know how your changes will impact the long-term relationship with consumers and your brand’s reputation.

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