Break-even analysis refers to the process of analyzing how much money a business needs to make in order to cover all its costs, both fixed and variable. Fixed costs are the basic costs that remain the same no matter what, while variable costs are the expenses associated with making products by volume. Combined these represent the total cost of production. The business must sell goods at prices that will at least break even with these total costs. Using break-even analysis to find out how this is possible can be useful, but it also comes with disadvantages.
First, break-even analysis must include all variables in order to be fully effective. All types of fixed costs must be included, along with all variable costs for running production or completing specific tasks. If a variable is missed, then the revenue created by each product may be artificially calculated and the business may think it is breaking even when it is actually losing money. Small mistakes or oversights can make the entire analysis process break down.
Break-even analysis can work well if the business is only interested in one product. But most businesses work with multiple products and costs that are not easy to assign to product lines accurately. This can raise the complexity of break-even analysis quickly. The results may not be highly accurate, and it may take too long to perform the analysis, raising costs and lowering the benefit of the analysis itself. Sometimes it is better for businesses to choose a different method to judge their success and plan future sales strategies.
Break-even analysis requires workers to focus on the bottom line, the point at which the business is not actually losing money. This can take focus away from making profit. By concentrating on making only enough to get buy, the business can begin to lower its goals, setting them closer and closer to this break-even point. This can lower the chances that the business will increase its profits and can create a negative obsession with making enough instead of innovating to find new ways to profit.
Break-even analysis can work well if no changes occur. Unfortunately, in business changes always occur. Prices for supplies rise and fall, production slows down or picks up, and demand moves under a variety of factors. This makes it difficult for analysts to accurately predict costs, especially in the future. For a very short-term analysis break-even points may be useful, but they cannot be used to plan strategies for an extended period of time.