23.08.2022

Analysis and break-even - what does it consist of and how to perform it?

Key information:

  • Profitability is an indicator of how much profit a company makes relative to its costs.
  • The break-even point is the point at which revenues align with costs to zero.
  • Profitability ratios make it possible to assess a company's financial position, determine the efficiency with which its resources are used, and see how well a company is doing against its competitors.
  • To conduct a profitability analysis, you need data from the income statement and balance sheet.
  • Profitability analysis allows you to manage your business more effectively, identify optimal courses of action and increase profits.
  • Profitability is just one of many indicators that should be considered when analyzing a company's financial and asset situation.

Break-even point (BEP) analysis is a short-term analysis. It includes studies of the break-even point, which tells us what sales performance, at given prices and costs, allows us to achieve revenues that cover the costs the company must incur. At the equilibrium point, the financial result is zero. The level of sales revenue above the break-even point leads to a profit, while a drop in sales below the break-even point generates a loss.

What is profitability?

Owning your own business is often associated by entrepreneurs primarily with profitability, that is, generating profits. Profitability is a concept that, in the language of financial analysts, means degree of efficiency of operation and management of company assets. Profitability analysis makes it possible to link the financial result to sales revenue, owned resources and equity. The higher the level of profitability, the better the financial position of the business.

Profitability indicators are a key element in the analysis of a company's financial and asset situation and are relevant not only to business owners, but also to individuals and businesses in their immediate environment, such as contractors, customers, suppliers or banking institutions.

Why perform a profitability analysis?

The company's profitability analysis will allow you to manage your business more effectively and efficiently. It will give you the opportunity to create a coherent development strategy, identify optimal courses of action and increase profits. In addition, it will allow you to determine the point at which your business will begin to turn a profit, as well as identify what investments will bring it tangible financial benefits.

High profitability will increase the value of your company, which is one of the most important benefits of running your own business.

Who is the profitability analysis for?

Not only entities with a developed structure such as limited liability companies, general partnerships, limited partnerships and joint stock companies conduct a profitability analysis. Also sole proprietorships can conduct this type of study. If carried out properly, it makes it possible to effectively correct management errors, establish an effective investment strategy and increase revenues.

Data needed for profitability analysis

In order to conduct a profitability analysis, data from the company's financial statements, especially the income statement, are necessary. It is this data that allows you to illustrate precisely how the company generates a financial result in a given period - whether it is a profit or a loss.

Profitability indicators

Profitability indicators, also known as profitability ratios or rates of return, allow you to determine the relationship between profit and capital and a precise estimate of the company's profitability in specific areas. These indicators also help illustrate the ability to generate profits and the ability to effectively invest new capital.

How to conduct a break-even analysis?

The break-even analysis is based on a breakdown of the total costs incurred by the company into fixed costs, which do not change with fluctuations in production volume, and variable costs, which depend on its volume.

In order to determine the break-even point, some simplifying assumptions should be made in the calculations, regarding price and cost:

  • Production in a given period is equal to sales
  • Total costs are linearly dependent on the size of production - variable costs are proportionally variable, and fixed costs are absolutely fixed
  • The selling price is fixed so that the sales revenue is proportional to the sales volume

We can determine the break-even point in two ways: the analytical method or the graphical method.

The analytical method involves calculating the break-even point with the help of the determinants, which are product price, unit variable cost and fixed costs. To determine the break-even point, we look for the level of sales at which sales revenue equals the total costs incurred by the company.

There are two types of break-even point - quantitative, which talks about the volume of production at which the financial result is zero, and valuable, which shows the minimum sales value that must be achieved in order not to incur losses. It is also useful for analysis percentage approach, determining how much of the anticipated demand should be used.

The graphical method involves placing the relevant data in a coordinate system, which allows you to read the break-even point, which is located at the intersection of the production value curve and the total cost curve. The graph also allows you to easily read whether you are in the profit or loss zone.

Benefits of profitability analysis

With the results, you will be able to develop the right financial and development strategy for your business - it will be easier for you to determine the right development directions that will allow you to make more profits. Profitability analysis It will also allow you to answer questions about the profitability of your investments and determine potential loan repayment terms. Above all, it will allow you to estimate the value of your business.

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    What is a profitability analysis used for?

    Profitability analysis is used in the day-to-day management of any business. Many managers ask themselves the question "When will sales start making a profit?". To be able to answer this question, one must use, among other things, a break-even analysis. Only after exceeding a certain volume of sales does the unit become profitable, and running a business is profitable.

    The break-even point is used to make decisions on determining the optimization of profit, and determining the prices of manufactured products, calculating the volume of production that ensures the achievement of the planned profit, as well as determining the impact of changes in production volumes, prices and costs on the level of the financial result of the enterprise. It is also used to assess the profitability of investment projects.

    Profitability analysis is important for any business. When undertaking financing decisions You can use the instrument of break-even analysis, that is, the study of its sensitivity to a change in such factors as product price, fixed and variable costs, sales volume, or expected profit. This is a useful tool for planning a company's activities in production, sales and price calculations in subsequent business periods.

    Natalia Marchelewicz

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