Pursuit of Passion (II) – Understanding Break Even Point

Pursuit of Passion

It is one thing to have a dream and take the plunge to turn it into reality, and quite another to sustain it. This journey of living one’s dream, is a test of one’s perseverance, and the conviction a person has in her own idea, helping her stay on course even in the midst of challenging and seemingly hopeless times.

In a past feature “Call of the Heart”, we advocated following one’s passion to help lead a richer and more fulfilling life. In “Pursuit of Passion (I)”, the first in a series of articles helping entrepreneurs get started, we had suggested ways to better define one’s business, identifying broad requirements of the business, along with associated costs and presented various ways in how a venture may be funded.

In the second part of this series, we seek to explain and even simplify concepts that will help you as you seek to grow your business and be more profitable.

For an operative venture, financials are like what the blood stream is to the human body. The financials need to be kept in order (accurate and timely management of financial records is the Bookkeeping or Accounting function) and better managed (financial planning, review and forecasting is the Financial Management function). In this article, we discuss Break Even Point, a very important concept which will help you in your decision-making and ensure your venture drives the kind of business results expected of it.

Break Even Point

Break Even Point is the point where the business does not make losses and is yet to make profits. In other words, a point where expenses equal revenues. In manufacturing units, it is expressed as the number of units that a business will have to produce to cover expenses and beyond which it starts to generate revenues.

Break Even Point is very useful to every business, small or big, as it helps determine the number of units that need to be produced and sold to be profitable. Additionally, it helps in decision-making on issues such as committing to additional expenses, capacity expansion, make v/s buy decisions (whether you should be producing something yourself or buying it from somewhere else).

Break Even Point analysis also helps explain the relationship between various costs – fixed (committed minimum expenses); variable (charged on per unit produced and dependent on number of units produced) and semi-variable (requiring a fixed commitment at varying levels of production), sales and profits.

Lets take an example to understand this well.

Minimum Quantity to Break Even

Mrs. Kumar runs an accessory studio, which makes fashionable and contemporary handbags.
Her Fixed Cost (FC) is the cost she has to pay irrespective of the number of bags she produces like machinery to make bag moulds, fix buttons, make packaging boxes.
Her Variable Costs (VC) include costs involved in the production of every bag that she makes, for example buckles and zippers used in the bags.

Some of her costs are semi variable (SV) in nature. She buys leather in bulk to ensure consistency of quality within a batch and to ensure she doesn’t run out of the material in the middle of her production. This is then consumed over a number of units until she orders again.

She is able to make 50 bags a month, and sells them at Rs 1500 per bag. Mrs. Kumar had taken a loan and set up this business, and she was wondering, “When will I actually start earning?” as all her money was just going in repaying the loans. Lets look at when Mrs. Kumar will be able to do so, how does the BEP analysis work for her?

Break Even Point (Units)
Pursuit of Passion

After doing her BEP analysis, she realizes, to repay Rs 100,000 or recover her Fixed Cost, she will need to sell 200 bags at Rs 1500 each. At the current rate of production, it would take about 4 months to do so, and from the fifth month, she would start making profits. Mrs. Kumar was quite relieved to know this, and ensured that she at least sold 50 bags a month for four months, anything over that was her Margin of Safety. (Number of Units produced over Break Even Point in a particular month)

From an organization point of view, it is very important that achieving Break Even Point is the core of your early strategy. Isha Sekhri, Chartered Accountant, Partner, for Sekhri Kanodia & Associates, talks about the importance of BEP analysis for a business, “One may feel happy and content with a revenue in the business. However, while it may seem that you are making what seems healthy revenue, but in fact, you may be making a loss; if the break-even point has not been worked out. It is important to work out the break-even point so you know how much you have to sell to cover your costs. The break-even point calculates the level of sales or services required to pay for all the overheads (fixed and variable) of the business, and at least come out even. It is important to identify your start up costs, which will help you determine your sales revenue needed to pay ongoing business expenses. This should be calculated over a 6 and 12 month period.”

Please write to us and let us know if this was helpful. We will bring you more of such concepts, which will help you to make profits and do your business in a smarter way. If you have any suggestions and want us to throw light on a particular topic, you can write to us at info@webopower.com and we would be happy to include it in our series.

Sources:
http://accounting4management.com/
http://en.wikipedia.org/wiki/Break-even_(economics)

Posted By: Fatema Jaliwala, Team WEBO
Illustration By: Shally Tayal, Team WEBO
Posted On: January 18, 2013

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4 Comments on “Pursuit of Passion (II) – Understanding Break Even Point”

  1. aditi.aditi05@gmail.com #

    Really liked the article, one of a very important calculations to evaluate ones business is to calculate the break even point. It gives a very real picture of the business. As a designer I find your article very important. It explains very nicely to calculate the break even point for those who do not come from business studies background.

    January 18, 2013 at 10:36 am Reply
    • Team WEBO Power #

      Thanks Aditi for your comment. It is nice to know that you found this article useful. Please do feel free to share your wishlist of topics that interest you and would be helpful for your business by writing to us at info@webopower.com. Team WEBO will try and include those topics in the upcoming articles.

      January 31, 2013 at 1:11 pm Reply
    • fatema01 #

      Thanks Aditi, I am glad you found the article useful. What you pointed out is exactly the aim of this series, to help entrepreneurs from non-financial backgrounds help manage their business more efficiently.

      Do let me know if there is a concept you would like know about, till then we will bring you the next one in the series!

      February 5, 2013 at 7:10 am Reply

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