In the previous post we considered how ‘Trend analysis’ is useful for answering common profitability questions, such as:
- Are profit margins eroding?
- Are losses increasing?
- Are expenses or cost of sales subject to fluctuations?
- Are there any significant one-off expenses?
- Are sales dropping, but fixed costs are remaining the same?
Another critical chart for assessing profitability is the ‘Breakeven analysis’. During the current period, many businesses are reviewing the impact of different revenue scenarios and adjusting overheads to preserve breakeven or minimise the losses.
This visual helps to assess how much of a downturn the business can handle. In other words, how far can revenues decline before the business will start to incur losses?
For any month, quarter or year, the Breakeven chart plots revenues, variable costs (ie. materials, commissions) and fixed costs (ie. rent, insurance) to calculate the breakeven point. At this point the business generates neither a profit or loss. Specifically, Earnings Before Interest and Taxes (EBIT) are zero. It is important to note that the business will still need to cover its funding costs (like interest) and pay corporate taxes.
Understanding the breakeven point is helpful for many purposes including setting sales budgets and preparing business plans.
Breakeven Margin of Safety
This chart also highlights the ‘Breakeven Margin of Safety’. This margin represents the gap between the current revenues and the breakeven point. This is the amount by which revenues can drop before losses (negative EBIT) begin to be incurred. The higher the margin of safety, the lower the risk of incurring losses. A higher margin of safety indicates that the business is better positioned to handle a decline in revenues.
Revenue scenario analysis
Using this tool you can quickly conduct scenario analysis for various Revenue outcomes. For example, what operating profit we would expect to earn, if the Revenue increased (or decreased) to a certain level? To do this, move your cursor to a target revenue level on the interactive breakeven chart.
There's never been a more important time to track your breakeven margin of safety. Log in to Fathom and take a look at the Breakeven chart to check your business's margin of safety and perform a scenario analysis.