Description of Break-Even Analysis
Break-even analysis is a crucial analytical tool used for risk management. The analysis allows managers to determine the amount of revenue required to cover all the costs associated with the production (Oppusunggu, 2020). Break-even analysis is important for managers to identify the exact amount of revenue that covers both fixed and variable expenses of the business (Elijah & Nneoma, 2020).
Fixed costs are expenses that remain constant regardless of production volumes, while variable costs fluctuate in relation to production volumes (Vipond, 2023). The more units a company produces, the higher the variable costs should be expected. Fixed costs remain constant regardless of the number of units produced by the company. Therefore, it is crucial for informed decision-making, especially in industries that require substantial investment.
Fixed and Variable Costs in the Chosen Industry
The industry of heavy equipment and engines is associated with relatively high fixed and variable costs, resulting in great expenses with moderate revenue. It shifts the break-even point for such companies further from the first years of operation. However, they are able to get stable profits after a few years of operations with a lower risk of losing them, as the example of John Deere shows.
The industry of heavy equipment and engines requires extensive investments in machinery and raw materials. Relevant fixed costs involved in the scenario include the cost of machinery, equipment maintenance, manufacturing facility costs, indirect labor (wages for administrators, managers, and supervisors), business licensing, research and development expenses, advertising, depreciation, and insurance.
Variable costs for the industry include raw materials, direct labor (wages of the employees directly manufacturing the product), freight costs, accounting, utilities, and legal consultation. Therefore, the industry of heavy equipment and engines can expect to have high expenses related to the start of manufacturing in addition to variable costs. However, fixed costs associated with equipment and facility purchases are required only at the beginning of the business, while later variable costs play a more significant role.
Application of Break-Even Analysis to the Industry
Therefore, a break-even analysis scenario for the industry predicts that the company needs to manufacture an extensive number of units to reach an equality of expenses and revenue in the first years of operating. Later, the role of fixed costs will not change, while the number of variable costs will rise with the increase in volumes. At the same time, heavy equipment and engine products have high prices, which reduces the number of units required for the breakeven point to be reached. Overall, companies in the industry can expect to get profits in the first 3-5 years of operations, considering the expenses and revenue.
John Deere’s Example of Break-Even Analysis
A clear example of break-even analysis in practice can be seen at John Deere, a major producer of heavy equipment and engines. The company produces agricultural, construction, and forestry equipment, as well as diesel engines (Equipment, n.d). The company sold more than 300,000 of wheel tractors in 2022, which is only a part of their operations (Deere and Co.’s number of units sold, 2023). Operating expenses of the company reached almost $43.5 billion in 2022, while revenue was $52.5 billion (Deere revenue 2010-2023, n.d). Therefore, companies operating in the industry have relatively high operating costs, which include both fixed and variable costs.
Chaves and Facion (2020) calculated that heavy equipment manufacturing involves almost the same level of fixed and variable costs per unit, which fluctuates insignificantly depending on the volume of production for large companies. Therefore, John Deere currently has a steady break-even point, with less than $ 10 billion in profits. It is unlikely that the company will experience a decline in profits in the future due to lower fixed costs and moderate fluctuations in variable costs.
References
Chaves, B., & Facion, S. (2020). Costs analysis of construction heavy equipment. 10th International Costs Engineering Conference, Rio de Janeiro.
Deere and Co’s number of units sold. (2023). Business Quant.
Deere revenue 2010-2023. (n.d). Macrotrends.
Elijah, A., & Nneoma, K. (2020). Break-even analysis as a management tool for decision-making in Babcock University Water Corporation. European Journal of Business and Management, 12(21), 159-181.
Equipment. (n.d). John Deere.
Oppusunggu, L. S. (2020). Importance of break-even analysis for the micro, small, and medium enterprises. International Journal of Research, 8(6), 212-218.
Vipond, T. (2023). Fixed and variable costs. Corporate Finance Institute.