Break-even analysis and marginal analysis are both very important equations for a business. Neglecting to review these two pieces of information could cause your business to fail or have you paying more than you need to for supply, salaries, or any other expense you might have. Although similar in nature, these two analytic tools are very different. Break-even analysis focuses on your entire business, while marginal analysis is more individually focused.
What is Break-Even Analysis
The break-even analysis examines expenses and income to determine the point at which your business will bring in a profit. To determine the break-even point, divide your fixed costs by the difference between revenue and variable costs. Fixed costs are expenses that will remain the same. This would include expenses such as equipment, interest, taxes or depreciation. Variable costs, however, change. These costs include costs of goods sold. They also include production expenses such as wages, utilities or other bills pending on your type of business. When you calculate your revenue, be sure to calculate the gross value. This way all aspects of your business are accounted for and you can visually see the exact point where you can make a profit.
Applying Break-Even Analysis to Business
If you price your product high, then your break-even point will come faster. What you’ll need to determine through research of your market is what customers will be willing to pay for the product. Sometimes a lower price may be worthwhile, even if that means taking longer to get to your break-even point. Investors, whether they are angel investors, a bank or a family member, will want to see a break-even analysis along with a plan of how you intend to repay them. The break-even point shows when and if you can make money from your business. If you don't have enough capital to continue your business until your break even point, then you'll need either to adjust your plan or find an investor.
What is Marginal Analysis
Marginal analysis reviews the cost and benefits to a certain factor in your business. The idea is to maximize your production. Performing a marginal analysis will allow you to see where you’re spending too much or too little, and from there you can make adjustments to your business plan. The simple equation for a marginal analysis is to subtract revenue by expenses.
Applying Marginal Analysis to Business
You would use marginal analysis when deciding on finding or switching suppliers, or evaluating the efficiency of your business. If you subtract your revenue from your expense, and your answer is negative, then clearly you need to make a change. Because marginal analysis is a tool geared toward small changes, it's beneficial when making management decisions as well. You have to ask yourself if you're gaining a great enough benefit from this choice so that this choice would be worth the cost or expense.
Should I Choose One Analysis Over Another?
When you're making decisions throughout your business, you'll use marginal analysis more often. In creating a business plan, you'll use both marginal and break-even analysis. The more you know about your finances the more convincing you can be to investors. Your business plan is a story. The marginal analysis helps to explain why you chose certain suppliers, location, equipment or employees. Although fixed costs stay the same, you can still use marginal analysis to decide on the lowest but most efficient supplies. Break-even analysis is the big picture. Investors can see you've made a knowledgeable decision on your costs and revenues because you've done a marginal analysis and as such have more respect for your break-even analysis. Throwing numbers together without research or thought is very easy. Having an accurate break-even point is one of the key tools that allow you and your investors to see whether your business is viable or not. Combining these two analytic tools is very important for a successful business.