In general, Break-even Analysis provides information about break-even levels of production and sales, the level of actual demand for a product, Target Profit and Margin of Safety (MOS).
Here are several examples of further uses of the break-even technique. The usefulness of Break-even Analysis as a scientific management planning tool for presenting costs and revenues data to aid strategic decisions can be summarized as follows:
- Product Portfolio management. Break-even Analysis can help to determine the expected Break-even Quantity prior to launching any new product to the market. If business managers know that expected sales from a new product are below Break-even Quantity having negative Margin of Safety, they will most likely cancel the launch and discard that product. On the contrary, if business managers know that expected sales from a new product are above Break-even Quantity having positive Margin of Safety, they will most likely go ahead with the launch of that product. Therefore, Break-even Analysis helps firms to manage their Product Portfolios. Although Break-even Analysis works best for single-product business organizations, appropriate allocation of Indirect Costs (Overheads) using Full-Costing Technique can help to assign each cost into every product making it possible for multi-product firm to also use the analysisÂ
- Risk assessment. By calculating Margin of Safety managers can assess the level of risk involved in Researching and Developing (R&D) a particular product. If Margin of Safety is above 100%, this is a very safe level allowing the firm to go ahead with the project. If Margin of Safety is negative, this is a very dangerous level causing the firm to make a loss from the project.Â
- Make-or-buy decisions. Should the firm produce a product itself or buy it from a supplier? Break-even Analysis can help to answer this question. The manager will make that decision based on the concept of Contribution (Contribution Per Unit = Price – Average Variable Cost (AVC). When Contribution Per Unit is higher when making the product rather than buying it, then the business should make the product by itself. When Contribution Per Unit is higher when buying the product rather than making it, then the business should buy the product from other businesses. In general, the business should accept the new order as long as additional contribution can be earned. This is because Indirect Costs (Overheads) must be paid anyway. And even though contracts are accepted using prices below the full unit cost, this can lead to an increase in the total profits of the business. So, the overall profits will increase.
- Pricing decisions. Price changes belong to the marketing. Any price changes, either increase or decrease in price, will have direct impact on Break-even Quantity. We shall assume that the Quantity sold will still be made regardless of price changes. Consequently, higher prices will increase Sales Revenue, therefore less products will need to be sold to break-even. And, lower prices will decrease Sales Revenue, therefore more products will need to be sold to break-even.
- Purchasing new equipment. Faster and more efficient machines that can replace production workers can dramatically lower Variable Costs (VC) of production. Any decrease in Variable Costs (VC) will also decrease Total Costs, and when the curve indicating Total Costs (TC) move downwards on the Break-even Chart, it means that the business will need to produce and sell less products in order to break-even which is good news. It is because it is easier, cheaper and faster to find less customers than more customers.
- Choosing between two locations. There will be different Fixed Costs (FC) in different locations due to different cost of land, different rent prices or the size of the office space. Constructing Break-even Analysis will be useful when building a new factory or relocating a business into a new office to due expansion (increase in business size) or rationalization (decrease in business size).
Break-even Analysis can also be used to assist business managers in making important business decisions by showing the current and new potential situations. Comparisons and forecasts can also be made between different products and their sales levels.
