The easiest way to destroy a business’s profits is discounting prices
The break-even point (BEP) for a business is the point at which total cost and total revenue are equal. There is no net loss or gain, and one has ‘broken even’. It represents the sales amount in either unit or revenue terms that is required to cover total costs (both fixed and variable). Break-even is only possible if a firm’s prices are higher than its variable costs per unit, so that each unit of the product sold will generate some ‘contribution’ toward covering fixed costs.
The main purpose of break-even analysis is to determine the minimum output that must be exceeded in order to make a profit. It also is a rough indicator of the earnings impact of a marketing activity. The break-even point is a simple management tool that provides a dynamic view of the relationships between sales, costs, and profits.
Business owners should calculate and analyse the BEP for their business when changing the following variables:
- A 10% increase in selling prices.
- A 10% reduction in selling prices.
- An increase of 10% in business costs.
- A decrease of 10% in business costs.
- A 10% increase in sales volume.
- A 10% decrease in sales volume.
Margin of safety represents the strength of the business. It enables a business to know what the exact amount it has gained or lost is and whether they are over or below the break-even point. In break-even analysis, margin of safety is the extent by which actual or projected sales exceed the break-even sales.
The BEP quickly highlights that the easiest way for a business to increase profits is to increase the selling prices of its products or services by 10%. Conversely, the easiest way to destroy a business’s profits is discounting prices. Discounting is a flawed strategy that destroys businesses.