Sunday, November 1, 2015

Break-Even Analysis: Two Answers

What can your manager do if a break-even analysis indicates that a venture will lose money?

The simplistic answer is that if a manager is looking at a break even analysis and the analysis shows that the venture will lose money is to not do the venture. 

Realistically though, the answer is more complicated than that. The simplistic answer assumes that all the variables in the equation are fixed – static without the possibility of changing. There are three variables in the equation for the break-even analysis. There are the fixed costs, the price you are selling your good or service, and the variable costs included in your service or product. All of these can be examined and perhaps tweaked so that the anticipated quantity is above the break-even quantity – can you charge more or pay less for inputs or not rent as big a space. 

One thing to be careful with is that these things are not strictly linear. If you pay less for inputs like labor, you might not be able to recruit the kind of people you want; if you try to up the price, you might dampen demand. (At that point, price and quantity demanded is dependent on the elasticity of demand of the good, and you’re calling in the economists to see if your estimated new price will support a break even quantity you expect.)