We are on the edge of a progressive recovery. A clear vision of your activities is needed and can be achieved by analyzing your profitability threshold.
In order to survive and regain momentum, you must review your corporate strategy and support your decisions with adequate data. To do this, it is essential that you analyze your profitability threshold and calculate the accounting “break-even” point.
Profitability threshold and break-even point: What are they?
The profitability threshold is the minimum amount of sales to be achieved during a targeted period to reach a balanced budget (break-even point). It enables you to determine whether a product or service is profitable, which is crucial information for supporting managers’ strategic decisions.
The accounting break-even point is a complementary indicator to the profitability threshold. It explains the relationship between cost, production volume and returns. It can be expanded to show how changes in the ratio of fixed to variable costs, such as raw material prices and revenues, affect a company’s profitability.
These two ratios are critical because they allow you to determine when your company breaks even, i.e., when it becomes profitable.
Know your profitability threshold to avoid flying blind
Analyzing the profitability threshold, but especially the accounting break-even point, allows company managers to establish different action plans based on key ratios. For example, they can use this data to set financial objectives and improve the profitability of a product or service.
In addition to being an essential management indicator, analyzing the break-even point helps determine when the company should start generating profits. Managing your business without these indicators is like running your business blind!
The importance of forecasts
Most companies have had to shut down or significantly reduce their operations in recent months. If they haven’t already done so, they will soon gradually start up again, and now, they have to deal with several completely new elements. During this gradual recovery, it will be difficult to know your actual sales. It is therefore important to make forecasts in advance that will allow you to restart or continue with realistic data.
Your sales, as well as the various fixed and variable costs, will have a direct impact on your profitability threshold and, consequently, on your accounting break-even point. Therefore, as soon as you determine these forecasts, you will be able to assess your project’s viability. If the forecasted data is not promising, you will be able to adjust your strategy accordingly, for example, by increasing your hourly rate or focussing on a more profitable part of your activities.
“Last year + 2%” no longer applies!
As you can see, there are many elements involved in calculating the break-even point. The many upheavals experienced throughout the supply chains means that companies’ forecast calculations are probably based on data that is no longer accurate. The benchmarks and reflexes must be revised. For a successful recovery, it is essential that you conduct a thorough analysis of the following.
There have been, and will continue to be, major changes in operations. Some entities have seen their business volume explode due to online sales but others, unfortunately, have seen a decline.
2. Fixed costs
Fixed costs are the recurring expenses that you have to pay, regardless of the company’s level of activity, such as depreciation, rent, administrative costs, various fees, salaries. This amount normally remains constant, regardless of your turnover. However, it is now important to take into account the subsidies offered by the government and other assistance measures from which you can benefit (exemption from/decrease in rent, agreement with banks for capital debt, non-payment of interest, etc.).
3. Variable costs
Variable costs, also called operating expenses, depend on the company’s activity and include, for example, supplies and transportation costs. Input prices are currently changing, this will have a direct impact on the contribution margin (sales – variable costs) and on the profitability threshold (fixed costs/contribution margin rate).
To ensure that you take into account all the variables needed to calculate the break-even point and analyze your company’s profitability, don’t hesitate to call on your trained professional accountant to assist you.
21 May 2021 | Written by :