Although some businesses are passion projects, the majority of businesses are formed with the goal of earning income. As a business owner, you also want to rake in the most profits to ensure business longevity and future expansion. However, sadly, a big portion of startups fail after its first year of operations. According to accounting services in the Philippines, the primary reason for that is due to improper tracking of income and expenses.
Bear in mind that one of the things business owners need to do is to set the right prices for their goods or services. You must be able to earn sufficient profit to keep running your business. Finance experts say that the breakeven analysis is a great tool to assist you in setting the right prices. Applying the breakeven analysis is ideally done before releasing a new product or service or before starting a business to avoid issues and anticipate the risks your decisions will bring.
Breakeven Analysis Explained
Doing a breakdown analysis will require you to use a tool for financial planning to better understand your revenues, expenses, cash flow, and determinants of whether your business will survive or not. Expert tax and accounting services in the Philippines say that the most crucial concept of this tool is the BEP or breakeven point.
If your revenue is equivalent to your expenses, your business has reached the breakeven point or BEP. Your business is not making any profit but also has not incurred any loss. Of course, although you should be happy that you’re not losing anything, you also want to continue operating with a big inflow of income.
The breakeven analysis is very important for business owners because when they calculate margins, the breakeven point is the lower limit of their profit. When you have this kind of figure, a cost evaluation is needed. The following questions may help you analyze how to go on about your pricing:
Are the prices of my goods/services too low, or the cost is too high to reach the BEP?
What adjustments can I make to my pricing so my business will be sustainable?
What is a good pricing structure to use so the customers will purchase my goods and make sure I make a profit?
How to Calculate the Breakeven Point
Check out this easy formula from expert tax services in Manila:
- BEP = Fixed Costs ÷ (Unit Selling Price – Variable Costs)
The equation represents the number of units of goods/services you need to sell to breakeven. Fixed costs do not change and remain the same just like rent or payment for a loan. Unit selling is the price of your goods or services, and variable costs are costs that do not change just like raw materials, utilities, and labor.
It shows that the costs have been covered. Every time there is an additional unit that you sell, it will increase your income by the contribution margin. The equation for the contribution margin is as follows:
- Contribution Margin (CM) = Unit Selling Price – Variable Costs
- BEP = Fixed Costs ÷ Contribution Margin Ratio
- CM Ratio = (Unit Selling Price – Variable Costs) ÷ Unit Selling Price
The Contribution Margin Ratio is expressed in percentages. Understanding the ratios will allow you to know what you need to do so you can breakeven. You can achieve this state by either increasing the price or lowering the production costs.
How to Use the Numbers in Your Business
The breakeven analysis is a great tool to use for business owners to learn how to properly set their production goals. It’s especially a great tool to use for startups that are setting up their initial pricing. But bear in mind that this fiscal tool is not only limited to that. The following are some of the circumstances where using the breakeven analysis might come in handy.
- Launching new products and you need to make a well-organized pricing structure
- Planning strategies for cash and profit to pinpoint the profit points for certain products and how much discounts to give during promotions
- Assessing current plans’ effectiveness
- Making a business loan and showing a figure that will help financial institutions understand the risk profile of the company
The breakeven analysis is a tool that can help business owners assess and check whether the plans they have made are feasible or not. If you don’t earn enough within the time frame you set, you can either lower your price or cut your expenses. It’s important to note that the BEP or breakeven point is not and will never be a market demand predictor. But it will certainly help you make future projections. If you need help conducting a BEP analysis for a new venture, call our team of CPAs offering accounting services in Pasig. Take advantage of our free 30-minute consultation.