The break-even margin is a calculation that focuses on identifying the margin factor that is necessary to achieve a break-even point between production and revenue generation. A ratio of this type is calculated by determining the total expenses associated with the operation and dividing that figure by the net revenues that apply to the same period. The resulting figure is then multiplied by 100 in order to determine the break-even margin percentage.
Taking the time to determine the break-even margin is helpful in several different essential tasks. By having a solid understanding of how much revenue is required in order to offset expenses, business owners find it easier to set pricing on goods and services sold. Using the percentage as the basis for the pricing, it is possible to balance the need to offer consumers rates that are competitive with similar products sold by other companies, but still realize enough return to cover the costs and make a little profit as well.
Another benefit to determining the break-even margin is that the process calls for identifying all related expenses. In the event that the ratio is not favorable, this can be a sign that a significant amount of waste is occurring during the production process. From this perspective, a poor break-even margin may provide the motivation for taking a closer look at how the operation functions, identifying areas where improvement will increase efficiency and reduce waste, ultimately allowing the company to produce each unit at a lower cost and increase the net profit realized from the sale of those units.
Since preparing to calculate the break-even margin calls for identifying all expenses, both fixed and variable, the results can also help provide an idea of what impact strategies such as entering into volume purchase agreements with different vendors is having on the bottom line. The presumption is that those contracts are resulting in savings on raw materials and other goods consumed as part of the production process, allowing the business to enjoy more profit from each unit sold. When this is the case, the break-even margin for each accounting period will become more favorable, owing to the incremental impact of those lower production costs.
The frequency of calculating the break-even margin varies from one business setting to another. Some companies may determine the current margin on an annual or semi-annual basis, while others may calculate the margin monthly or even on a weekly basis. Determining the frequency often depends on how quickly changes occur within the operation, including new policies and procedures that could reduce waste or otherwise decrease the cost of production, making sure those changes are saving money without creating a drop in quality that could ultimately mean a loss of customers.