Breakeven analysis is an examination of costs and income of a business showing what needs to be achieved to ensure that revenue costs are equal to revenue income - Breakeven Point (i.e. so no loss is incurred) - and what additionally may need to happen to achieve a profit/surplus of revenue income over revenue costs.
Similarly, a sensitivity analysis allows the different elements of the costs and income of a business to be manipulated to see what the financial impact might be.
As part of the work of compiling revenue projections it is possible to use breakeven and sensitivity analysis to consider both the impact of financial risks and to provide an input into decision making about the price that should be set for the services or products of the business or the level of performance required (levels of occupancy, numbers of bookings etc) to ensure that the venture does not start making a loss.
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Breakeven Point - an example A development trust called "Offices 'r' Us" is planning to bring to market 10 new single office units in an old converted school. The following shows fixed and variable costs that are associated with the project. |
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Cost item |
£ |
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Fixed costs (annual): |
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Mortgage interest payments on loan to convert the school |
30,000 |
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Business rates |
2,000 |
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Caretaker salary |
14,800 |
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Building insurance |
4,000 |
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Lift maintenance |
1,200 |
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Variable Costs: |
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Heat and Light Standing charge per unit quarterly |
20 |
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Heat and light usage charge per unit quarterly |
130 |
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Telephone and internet costs per unit |
370 |
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Cleaning costs per unit (weekly) |
10 |
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Each office is being marketed at an all inclusive cost of £200 per week |
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Answer |
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Fixed costs per annum |
£52,000 |
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Variable costs per unit per annum (£20x4 + £130x4 + 370x4 + 10x52) |
£2,600 |
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Total Contribution per unit per annum (£200 per week x 52 weeks = £10,400 per annum - £2,600 = £7,800) |
£7,800 |
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Total Number of Units = 10 |
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Breakeven point = Fixed Costs (£52,000) divided by Contribution per unit (7,800) = 6.6 units |
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So 7 units need to be occupied (a 70% occupancy rate given that there are 10 units) for breakeven point to be reached. |
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