The Break-Even Point, Assessment Example

A breakeven analysis is a useful tool for the determination of the point at which gains are equivalent to losses (Brealey et al., 2009). As such, it assists business professionals in predicting when their investments will generate a positive return. The breakeven analysis is beneficial when these individuals wish to gain a greater understanding of the relationship between the cost, production value, and returns of a particular product. This helps them determine how changes in the fixed cost/variable cost relationship will impact the breakeven point, which allows them to run a variety of models and simulations to calculate which conditions can generate the highest profitability. These figures also represent the smallest amount of profit that is required by a company in order to prevent losses.

Despite the usefulness of the breakeven analysis, there are several limitations (Smith 2014). First, it is best suited to analyze a single product at a time. This is advantageous for companies that have only one major product or service, but this is less so for companies that issue a variety of items. Ultimately, adding more products to the breakeven analysis make it more complex since adding a greater amount of variables to the calculation make the probability of the predicted breakeven point less certain. Therefore, to increase the likelihood that the prediction will be correct, only one variable should be considered at a time.

Next, breakeven analyses are not always effective because it is difficult to classify a cost as all variable or all fixed. The breakeven calculation assumes that this is the case, which does not mirror reality. Therefore, we must assign variable and fixed values to a product or service even though these numbers may not always be constant in reality. In this manner, the calculation reminds us that this analysis is simply a matter of prediction and probability than a reflection of realistic trends.

Last, many business professionals continue to use a breakeven analysis even after the cost and income functions have changed. This is erroneous and it is important to consider that changing variables must be factored into these calculations. Essentially, this indicates that the breakeven analysis is its most accurate when the variables that the equation utilizes remains completely static. However, this rarely occurs in reality and the equation should therefore be used only if potential error is considered in order to ensure that the best business decisions continue to be made.

To the Executive Board of Midland Computers Company

It would be advantageous for the company to resolve the current profitability crisis according to the preferred suggestion provided by Imran Malik, Director of Finance. While the “new horizons” plan is the one that has the highest degree of risk involved, it has the greatest potential for allowing the company to take advantage of the resources that it currently has in order to make a greater profit. One of the most troubling aspects of business is that “the draft budget assumes that the factory will only be working at two-thirds of maximum capacity and sales above maximum capacity are not possible”. It is therefore necessary to determine whether this assumption is realistic. If this is the case, the company would benefit from expanding into EU markets so that it could utilize its full production capacity. This would help minimize the losses from overhead costs for not utilizing the equipment to its full potential.

A second cause for concern is that the company currently “operates a Just-In-Time stock control system, which means it holds no stocks of any kind”. In order to increase profitability, it would be beneficial for the company to become publicly traded, and this effort would become enhanced by expanded to the EU market in order to increase the potential of purchased shares. Doing so will provide the company with the funds necessary in order to ensure that they are able to fund their current plans for expansion, which can be utilized in the future to enable further extension plans if such is deemed necessary.

Ultimately, it is important to consider that the expansion will be costly, but it will rake in more profit at the end, which is the current goal of the organization. While the fixed cost of operations will increase, the revenue for the company will increase at an even greater proportionality. Furthermore, the risk is somewhat mitigated by engaging in market diversity, which will allow for greater business opportunities. Thus, the plan proposed by Imran appears to be the most ideal for enhancing the profitability of Midland Computers Company. It is in our best interest to follow his informed recommendations. This will allow more items to be sold during the next business year in a manner that will not detract from current business and only allow it to be supplemented.

References

Brealey R, Myers, SM. Maynes EM. (2009). Fundamentals of Corporate Finance. McGraw-Hill Ryerson.

Smith C. (2014). What Is the Break-even Point and What Decisions Can Break-even Analysis Help an Organization Make?Chron. Retrieved from http://smallbusiness.chron.com/breakeven-point-decisions-can-breakeven-analysis-organization-make-22846.html