Why Do a Break-Even Analysis?
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A break-even analysis is a method used by company owners to determine how many units they need to sell and at what price to earn a profit.
To calculate the break-even threshold, the study considers a company's fixed and variable expenses, as well as the selling price.
A break-even analysis may also be used by a company owner to evaluate whether it is preferable to purchase or lease equipment in order to optimize earnings.
Analyze the break-even point. This is something I'd want to discuss.
I'd want to go a little further because this is a, and there are a lot of important lessons for you in there, so every company has what we call. When you add up all of your costs, you'll see that you have fixed and variable expenses.
A fixed expense is one that occurs every month regardless of whether you make a sale or not, such as your rent or phone bill. Whether you make a sale or not, those sorts of things happen every month. If you own a retail store, the clerk who works at the cash register is a fixed cost that you must pay whether or not anybody enters through your doors.
We also have variable costs, thus in the case of a retail company, I must replace a product every time it is sold.
Those are expenditures that are subject to change. I don't have the money to replace that thing until they sell it, right?
If I run a services company and employ contractors to do the job, I'll tell you about it. One of my earliest ventures into the industry was an invisible fence company.
Many of you are undoubtedly familiar with the concept of invisible fence, but I can tell you that it was only two years old when I was engaged with the business. We were the only ones who could speak about invisible fence since they had a patent, and to be honest, I spent a lot of money on customer acquisition expenses because my consumers had no clue.
They came up with two options for keeping Fido in the backyard as soon as they thought of it: chain link and dot k fence. That was the end of it.
They were unaware that they had another choice. Do you recall the bonus points?
They didn't realize they had a game point until I reached a gain point. I had to inform them that such an option existed.
Okay, go ahead and do it. But, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but, but All I'd have to do now is purchase an invisible fence. This is what makes this franchise unique in that I had to pay every time I purchased a system. It comprised not just the hardware, but also all the variable costs that had to be returned to the parent business.
The remainder was margin for me to deal with, which I could now put toward client acquisition expenses. I didn't have much; a lot of the marketing was done on a national basis, and I didn't have the resources to accomplish it.
So I had a lot of variable expenses, but not a lot of fixed costs, so I was able to do it. So, this is a story about two distinct companies, and you don't need to know how to read a scale to understand it. But what occurs is that we think about it for a month.
We know that this blue line here is a part of our fixed costs. So we know we dug ourselves a hole at the start of the month since we had to commit these money to things that we had set expenditures for.
However, every time I sell a unit, it is on the low end of the market. You don't have to read the scale again.
Every time I sell a unit, it costs me a little more to purchase it, but I also have a retail price for my product or service that reflects this yellow wine, and they cross over at some point.
So, if I just sold this many units, one might argue that I would, I could look at the difference between these two lines and decide that, quite honestly, we utilized it on the scale here. Because everything in this triangle is a loss, this is how much money I'm going to lose.
At this moment, everything in this triangle is what we term profit or margin, okay? Now, the reason I have two of them is because, similar to my invisible fence tale, I can occasionally swap my fixed costs for some variable expenses.
As a result, I begin with a considerably lower number. So consider that building firm.
Rent the backhoe instead of buying it. You know that renting a backhoe will cost you a lot more money than buying one, right? However, if I had no business that month, I would not have that cost.
As a result, it becomes a variable cost. If I own a net backhoe, I have principle and interest payments, which are a fixed cost, right?
So, here's the thing: this is the important part. It was just halfway to my break-even point if I still had sales down here. This is the amount of money I lose.
Would you rather lose this amount of money or that amount of money? Wouldn't you rather have the right side?
So, let's get to the point. Here, two things happen. One is, how much of my fixed expenditures am I able to manage?
Not a whole lot. What percentage of my variable cost do I have control over?
They don't have much say since they're dictated by others. What I can control is how much I charge for my goods or service.
As a result, I have control over the slope of this yellow line. So, if I raise the price, my crossover point will be reached sooner. But that worked, and now I need to grasp the marketing aspect, which we'll discuss in a moment, to see whether the market would bear that price.
So you're short on cash. I don't have much control over costs, but I do have control over how much I charge for my goods.
All. Right? Don't overcommit members to that contingency concept, says the second half of the statement. You don't want to purchase something that is unemployed later on, therefore don't afford to pay lost rent before you buy.
If you're going to be in the laser cutting industry, no one wants to have one. If you want to open a kitchen, see if you can rent a place instead of buying and building your own. We no longer want to be in this model after you get traction and beyond your break-even point because, again, if I sold up here, this is how much money I'd earn, the profits I'd receive, and I'd rather have that profit.
So, after I figure out where my break-even threshold is, I'll be able to decide whether I should purchase or rent. Because I want to be in this model before I reach my break-even point after I've regularly exceeded my break-even threshold.
I'd want to be a part of that model. As a result, higher variable costs are preferable in the beginning. It's preferable to have less variable expenses. Once you've established yourself, you may begin rating cashflow.
That makes logical, right? It's a subject that I'm interested in learning more about. That's all fine. That's what we'll call operational leverage.