Breakeven Analysis - Strengths and Limitations

Break-even analysis is a practical and popular tool for many businesses, including start-ups.

However, you also need to know about the limitations of the method.

Here is a summary of the key issues from the perspective of a startup or new business, for whom breakeven analysis is particularly relevant and important.

Strengths of breakeven analysis

Focuses entrepreneur on how long it will take before a start-up reaches profitability – i.e. what output or total sales is required

Helps entrepreneur understand the viability of a business proposition, and also those who will lend money to, or invest in the business

Margin of safety calculation shows how much a sales forecast can prove over-optimistic before losses are incurred

Helps entrepreneur understand the level of risk involved in a start-up

Illustrates the importance of a start-up keeping fixed costs down to a minimum (higher fixed costs = higher break-even output)

Calculations are quick and easy – great for giving quick estimates

Limitations of breakeven analysis

Unrealistic assumptions – products are not sold at the same price at different levels of output; fixed costs do vary when output changes

Sales are unlikely to be the same as output – there may be some build up of stocks or wasted output too

Variable costs do not always stay the same. For example, as output rises, the business may benefit from being able to buy inputs at lower prices (buying power), which would reduce variable cost per unit.

Most businesses sell more than one product, so break-even for the business becomes harder to calculate

Break-even analysis should be seen as a planning aid rather than a decision-making tool