Discuss the various uses for break-even analysis
A new business must know what gross sales volume level it must achieveto reach the break-even point before it can record a true profit. Breakevenanalysis determines the operating costs for a business, as well as recordsits absolute profits. Thus, even a "mature business would be wise to lookat their current break-even point and perhaps find ways to lower thatbenchmark to increase profits. The recent massive layoffs at largecorporations are directed at this goal, lowering the break-even point andincreasing profits." (Business Town.com, "Break-Even Analysis, 2003)What factors would cause a difference in the use of financial leverage fora utility company and an automobile company' Utility companies are often legal monopolies, controlled by thegovernment, or experience only limited local competition, unlike automobilecompanies that are private and experience international and nationalcompetition. Financially, the automobile company has greater opportunitiesto expand its profits but also a greater opportunity to experience greaterlosses in an indeterminate competitive environment. Specifically, in terms
The firm cedes a certain amount of control to its lender and rendersits permanent assets subject to outside influence when accepting financesfrom outside of its business structure from a lender. When determining when a company will break even, the depreciation ofcurrent operating resources and the physical fixed costs of the businessmust be taken into consideration. Capital is not factored into a 'break even' analysis. Operating leverage is the name given to the impact on thefirm's operating income that occurs with a level of change in the firm'slevel of output. Discuss the limitations of financial leverage. The break-even point is determined by a company's operating costs, whichinclude labor. utomobile industry also has a greaterproportion of fixed costs than the utility industry, and thus may be lessattractive in terms of securing financial leverage. Cash flows are short term in nature,measuring the firm's current financial operating costs at a specific pointin time, not taking into consideration the age of the mechanical resourcesbeing used, for instance, or the need to increase wages for workers overtime. (Scott, 1998) Also, if a high percentage of afirm's costs are fixed, and hence do not decline when demand decreases, andoperating costs remain high, this increases he company's overall potentialbusiness risk. Also, the higherthe rate of cost of borrowing to the firm, the higher the risk to the firmof financial leverage. Thus, the lender takes a risk in lending to the firm in acase of financial leverage and the firm takes a risk in taking anotherindividual 'aboard' in the firm's activities. (Scott, 1998) But theautomobile company has more areas of potential profit making, as well asmore areas on its books to accrue potential losses, because of costs itmust put into its production. Financial leverage isthe name given to the impact of on a firm's financial returns, of thechange that occurs to the firm's assets when that change is financed withborrowed money. How does the interest rate on new debt influence the use of financialleverage' The lower the interest rate, the more attractive it is to borrow froma lender, and thus the greater the potential attractiveness of financialleverage. However, the greater the company's proportion of fixed costs, the lessoperating leverage it possesses-in other words, the less ability thecompany has to cut operating costs to maximize profits.
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