Analyse and evaluate the usefulness of a Break-Even analysis for a business. 14 marks

A break even analysis is an analysis made by the entrepreneur of a business based on the cost of production and the predicted sales that will be made. The point at which the amount of sales meets the production costs is known as the breakeven point. Businesses aim to have a low breakeven point, so it isn’t too difficult to make a profit, the goal of any private-sector business. However, there are several constraints to using a break-even analysis.
The first and main constraint is that it is just a prediction based upon what could happen in the future with the business. There are no actual sales figures for the time period that the analysis is covering, and, for this reason, makes it being a prediction a major constraint. Alongside this, the assumption that all products are sold is very unrealistic in business, for example trends may change which would reduce demand, or a competitor may be able to produce the same products for a cheaper price, which would mean that not all of the products would be sold. A third and final constraint of the analysis is that it oversimplifies business. It makes business appear to be an easy world to crack, for example making assumptions about costs may be optimistic because the entrepreneur knows the level of profit that they want from the business, which would reduce the reliability of the analysis, and, in turn make it less useful, because the assumptions would be wrong and therefore would lead to an inaccurate break-even forecast.
However, alongside every constraint there is a benefit. The first being that because the analysis is so simple, it is accessible to most entrepreneurs. It isn’t a difficult thing to calculate, and, for this reason makes the tool a useful one for a business. In the same way, it can be modified and used for “what if” situations if it is created on a computer, you could amend the figures to look at worst case scenarios, and make a decision as to whether you continue with a business plan or modify it to something safer. The tool is especially useful if a business is thinking of moving into another market, for example if they already sell soap and they want to move into the shampoo market, they could analyse the benefits and constraints, and how long it would take to recover their investments, and quite simply whether it would be worth it. So break-even analysis’ is a useful tool for making informed business choices, with worst-case scenarios easy to view from the chart. Finally, the tool can be used as a supporter for a business applying for a loan, along with cash flow forecasts and balance sheets, to show the potential investor what the money that they would be lending would be going to, and how long it would take for that investor to recover their costs.
In conclusion, a break-even analysis is a very useful tool for an expanding business. It is a tool that could reduce diseconomies of scale happening in a business because it helps the firm to predict what may happen if they complete a particular investment, in other words it helps to make wise choices about opportunity cost. However, being a prediction, it is always going to have drawbacks, because raw materials may increase in cost. As well as this, because the analysis relies on all of the products being sold, it doesn’t reflect what is going to happen realistically for most businesses. So overall, for predicting and making informed choices about whether to expand or not, the analysis is good. For making decisions that regard the near future it isn’t such a useful tool.