Break-even - OCRUsefulness of break-even in decision making

Using break-even to make business decisions

Break-even can be helpful when a business wants to make decisions. It is particularly useful for making decisions about:

• New products – break-even can be used to predict how many units would need to be sold, and the business can judge whether this would be realistic based on their market research
• Pricing – break-even can be used to see how different pricing strategies might affect the break-even point, and the potential profits of a business. Charging a higher price might increase revenue, and this could lower the break-even point. However, increases in price can result in lower sales, which could increase the break-even point.
• Costs – break-even can highlight the impact of changes in either fixed or variable costs. This could help to decide whether to change suppliers (variable costs), or whether to invest in new premises (fixed costs). If a business is able to decrease costs then the break-even point will fall.
• Production levels – knowing how many units need to be sold in order to make a profit can help a business to plan production levels. The break-even level can be used to plan what equipment, and how many staff might be needed.

The limitations of using break-even to make business decisions

Break-even often uses forecasted figures and assumes that the business can sell the units that it produces. This means that it does need to be used with care, as there are a number of things that might affect the forecasted break-even point. These include:

• Marketing activities – any marketing activities that involve price reductions will affect the total revenue received. If successful, such a marketing campaign may lead to an increase in sales that is sufficient to increase total revenue. This would lower the break-even point. However, if prices are reduced and sales fail to increase sufficiently, then total revenue may fall, resulting in a higher break-even point.
• Changes in costs – the costs used to calculate the break-even point may not be accurate if they are based on forecasts. Even if they are accurate, there may be unexpected changes costs, such as the price of raw materials increasing. Any increase in costs will lead to an increase in the break-even point.
• Changes in external factors – a change in things beyond the control of a business can also affect the usefulness of break-even. For example, if a new competitor launches a better product, the sales and revenue might be lower than forecasted.

In addition, whilst break-even is good for businesses that produce products that it sells for the same price, it is less useful for businesses that provide services. This is because customers may pay different prices based upon the service they request. For example, a hairdresser will charge more for colouring and cutting somebody’s hair than they would for a just cutting it. This makes it more difficult to predict revenues accurately.