BUSINESS: financial foundations
Break-Even Point Analysis
Use this formula to determine when you generate a profit.
DAVID MILLS, O.D. , M.B.A.
Financial managers must know how to determine their break-even point, as it gives insight on how much revenue must be generated to cover costs and achieve a profit.
Here, I explain the break-even point calculation as well as how to use the formula to increase your profit.
Calculating break-even point
At the break-even point, no profit has been generated, and no losses have been incurred, so all revenues generated after reaching the break-even point are profit.
The formula: Break-even point = Fixed Costs/(1 – Total Variable Costs).
To complete this formula:
1. Calculate the total variable expense as it relates to the increase of revenues generated. The total variable costs formula: Variable Expenses/Revenues
Remember: Variable expenses are the recurring costs that are dependent on the volume of services or products produced or sold. This varies but can include increase in staff time.
2. Insert fixed costs into the break-even point formula to determine the revenues needed to reach this point. For example, you may be contemplating purchasing a new piece of equipment. The monthly fixed cost lease payment is $2,500, and you estimate the monthly variable expenses associated with this purchase will be an additional $1,250. After reviewing your patient demographics to see who fits the equipment’s profile, you believe you can generate $3,400 in additional revenues.
In this example, total variable costs equals .37 ($1,250/$3,400). Therefore, the break-even point is $3,968.25 ($2,500/(1 – .37)).
Next, determine the number of patients needed to reach the break-even point. If you assume you generate $100 per patient in additional revenue from using the equipment, you need 40 patients per month to begin generating a profit ($100 × 40 = $4,000, which is greater than the break-even point).
This method of determining the break-even point gives you a more accurate and realistic value than the often-used formula of the monthly lease payment divided by the expected revenue per patient, which does not account for variable expenses as discussed above. Given the previous example, this formula would lead you to believe the break-even point would be reached after 25 patients, a significantly different value than the one above.
Knowing the break–even point allows the business manager to develop strategies to generate greater profits. For instance, one strategy could involve lowering fixed and variable costs. You could accomplish this goal by instituting inventory controls as well as properly managing employee work hours. However, you shouldn’t make changes that could negatively impact patient loyalty or employee morale, such as drastically cutting employee hours.
Also, determine potential areas where fee structure can be adjusted — any additional collected revenue lowers the break-even point.
Turning a profit
Whether contemplating purchasing a new piece of equipment or analyzing the financial health of your practice, determining the break-even point is the quick and ideal way to calculate when you will generate profit. OM
Optometric Management, Volume: 49 , Issue: April 2014, page(s): 62