breakeven point control for higher profits
TRANSCRIPT
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How can management be tough-minded as
to rising costs, flexible as to changing con-
ditions, resourceful as to future planning?
Breakeven
Point Control
for Higher Profits
By Fred V. Gardner
When sales mount, as they have for many
firms since World War II, costs generally go up
too.
B ut whfen sales level off an d de clin e, as
they are begiiiining or threatening to do in many
product lines and divisions of even the most
prosperous companies today, costs do not follow
quite so easily. N o matter how muc h costs
should go down as sales drop, in fact they hardly
ever bebave that way.
Th e reasons for this are clear. A period du r-
ing which sales are easy to come by leads to
lackadaisical cost control and an undermining
of the profit motive. Sheer volume makes the
company loolt good, and top executives do not
pay enough cjritical, discerning attention to the
attitudes of junior executives, to planning and
forecasting, dr to prod uctive efficiency. In ad-
dition costs have become far less flexible as a
result of involved government regulations and
restrictive labor contracts, as a result of the
ponderousnesB of modem line-staff organiza-
tion, and as a result of just plain physical factors
like added space (the distance from the front
door to the back door of the plant is far greater
today than it used to be).
Consequently, executives run into great diffi-
culty when, ^s volume shows signs of slipping,
they try to get costs in line with sales. Th ey see
clearly that i( 70 cents in costs were added for
each dollar of increased volume during the ex-
pansion years, 70 cents must be removed for
each dollar of lost sales, or the breakeven point
will climb to a dangerous level. But how can
management instill cost-consciousness in young-
er executives who have never experienced the
problems involved in coping with falling vol-
umes, educate them to take a more critical look
at some of those costs that have come to be re-
garded (however wrong ly) as "fixed"? W h at
can be done about excessive costs due to slow-
moving inventories and other such causes?
And is it not true that in order to take away
some of a competitor 's business, the company
must reduce prices, thus raising the breakeven
point still further?
It may be well-nigh impossible, when busi-
ness slips, to reduce costs at rates comparable
to increases in costs when business goes up.
But it is possible to take a far tougher attitude
toward costs than most managements do today.
I am not thin king of the kind of excited, panicky
pressure from above to "cut costs anywhere"
that all too often has characterized manage-
ment's approach in the past; that may do more
harm than good. Rathe r, I am think ing of the
tough-minded, hard-headed "figure approach"
that (a) pinpoints causes of trouble as they
develop not aft-erward; (b) shows clearly and
forcefully the effect that poor performance in
any division, department, or shop has on the
over-allcompany breakeven point; and (c) "puts
the bee" on executives to move on their own
initiative when costs get out of line, regardless
of whether there is pressure from the top and
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Harvard Business Review
regardlessofwh ethe r profits are risingorfalling.
In this article I shall discuss theworkingof
this approach, which I call "breakeven point
control." Let us begin by considering briefly
the needforbreakeven point controlasopposed
to conventional accounting; then turn to a de-
tailed step-by-step analysis
of how and why it
works, relying notongeneralitiesbut on specific
figures anda concrete case situation.
Need for Flexible Control
In planning theattackon costs, management
should remember that cost control problems
arise,
in the main, becauseof the fact thatex-
ecutives must plan ahead
in
time, that they
"deal in futures."
Tbis is soobvious th atwe arelikelytoover-
look itsim plications. If all inventory, expendi-
ture, financing, depreciation, investment, and
other problemshad time sequencesof onlyone
moment, say, or onemonth, thedifficultiesof
management would bem inimized. But, unfor-
tunately, the cost decisions that come to man-
agement range from those which can be made
every day on the basis of volume fluctuations
(for example, the number of salesmen to send
out to sell a line of merchandise) to thosere-
quiring planning overan extended depreciation
period
(for
example,
an
investment
in
machines
which are capable of producing productsnow
onlyon the drawing boards).
It is because of the importance of the time
or "turnover" factor that policy makers often
find accounting so frustrating. Conven tional
accountingis an exacting science. It reportsin
termsof static conditions, usually after thefact.
It reckons that thecompany m ade a givenper-
centage of profit for a given period of timeon
a given volume. All this is fine, but it does
not account for the dynamic factors. And it
does not account for the fact that some cost
items repeat themselves faster than others, that
some machines areused up faster than others,
that some inventories turn over faster than
others. Accordingly, accounting often hasvery
hmited helpfulness tomanagement in termsof
where actuallytoturn in orderto control costs.
acom-
Tbe Breakeven Point
By contrast, the breakeven point
mon term in business parlance but not an
"accounting" term
does reflect
the
dynamic
factors which affect profits.
A business has a breakeven point because
of different rates of turnover and activity. If
all costs varied directly with volume, there would
be no breakeven point; the company would
make money on the f irst $i,ooo of sales. On
the other hand, if all costs were more or less
constant (which they
are not), the
breakeven
point wouldbestatic,notmoving (whichit is),
and cost control wouldbe apretty cut-and-dried
business. But the company has both standby
and variable costs,and it isbecauseof this that
there is a breakeven point. (To me the term
fixed costisvery unsatisfactory, becausenocost
is really fixed;^ I prefer to label expenditures
that continue regardless of production levelas
standby costs.) It is also because of the dual
nature of costs that the constructive way for
management to think about profits is not in
terms
of the
usual formula
Profits
=
Sales
Costs
but in terms of the formula
Profits
Sales [Standby -\- Variable Costs].
Even though many managements purport to
know their breakeven points, they usually know
them only in a superficial, haphazard way.
They know them in terms of static, "account-
ing" costsand generalities like Ourcostsarex
dollars, so we will havetohaveydollarsinsales
to get them back," instead of specific, variable
costs. They cannot put breakeven pointstotheir
really important
use,
which
is for
budgeting,
forecasting, and controlling costs.
A breakeven point moves witb changingcon-
ditions (e.g., fluctuations in salesor inprocure-
ment costs) and, in moving, flashesa warning.
If management doesnotheed tha t w arningand
follow through with appropriate action, the
annual budgetand theforecasts onwhich it is
based soon become obsolete for all practical
purposes especially in years of great eco-
nomic change when they are most needed. No
wonder many executives say,"Budgets I don' t
want them. They just confuse me."
*
Once the breakeven idea is integrated into
control thinking, then it is comparatively easy
to compare thepast with thepresent, andboth
with the future. Present forecasting methods
too often areunsatisfactory because it is hard
to visualize plans in termsof the actualitiesof
the past, especially when thevolum e forecasted
is different from immediate past experiences.
The breakeven approach sharpensthe effective-
See,
for
example, Bruce Payne,
A
Program
for
Cost
Reduction,
H A R V A R D BU S I N ES S R EV I EW ,
September-
October 1953,
p. 71.
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ness of forec|asting because the projected figures
can be muclj more intensively analyzed in rela-
tion to what has happened or is happening.
System in Operation
Now let us turn to the actual operation of
breakeven point control. As a concrete basis
for discussion, take the case of the "Wisconsin
Manufacturing Company" (disguised name).
Its situation is representative of that in which
many divisions of medium-size and large com-
panies and also many whole small companies
find themselves today. Let us suppose tha t the
management of the Wisconsin Manufacturing
Company, faiced with the necessity of preparing
for rougher weather in competition, turns to
breakeven poin t control. How will manage-
ment go abojit drawing up a budget, making an
analysis, and deciding what action to take?
Cont ro l Da ta Needed
To begin, management needs to have certain
kinds of control information. T he list migh t be
developed as follows:
1.
reakeven factors
These are the difEer-
ent standby ind variable costs, from direct labor
to administrative expense, as computed by the ac-
coun tants. Although the exact breakdown will
vary from company to company, two general rules
are important:
(a) In some cases, a total cost will need to be
divided into its standby and variable components.
For example,; the total annual figure for factory
overhead may be $6 20 ,7 00 . But part of this cost
is a variable depending on the number of shifts,
on volume
ot
production, and so forth. Th e ac-
countants need to isolate the standby portion and
record it separately. W hen this is done for Wis-
consin, the standby element comes to $294,000
and the variable to $326,700.
(b) The standby cost can be entered on the
budget as a yearly figure. But the variable cost
should be entered as a control figure per $100 of
forecasted n et sales. For example, since Wiscon-
sin's net sales forecast is $2,700,000, the variable
cost for factory overhead would be listed as $12.10
per $100.
2. reakeven performance figures These are
the yardstick figures to be used in judging the pro-
posed budgets of department heads. They are com-
puted by simjple arithmetic on the basis of the
breakeven faqtors and the sales forecast. For ex-
ample, Wiscoiisin's direct labor cost of $10.80 per
$100 of net iales produces a budget allowance of
$291,600 fori a sales forecast of $2,700,000.
reakeven Point Control 125
It needs to be emphasized, of course, that man-
agement should not regard these yardsticks as final.
For instance, the figure of $10.80 for direct labor
cost may refiect inefficiency in the shop. It is used
simply because it is the best available cost figure
based on past performance. As performance is
improved in the future, it will change.
3.
Depa rtmental budget requests
These are
the budget figures submitted for management ap-
proval by the department heads. They will be
compared with the breakeven performance figures.
4.
Percentage
comparisons
These are the
control figures indicating how the breakeven per-
formance figures compare with the proposed de-
partm ental budgets. They are best expressed in
percentages, the former divided by the latter. Th e
lower the percentage, the more unfavorable the
eontrol figure.
5.
reakeven points in net
sales
The break-
even points are obtained by dividing total standby
costs by the
profit pickup
(see bottom line of
EX -
H I B I T
i) . They are key figures for top managem ent
because they point up the soimdness or unsound-
ness of the cumulative departmental budget re-
quests. To illustrate, with breakeven perfonnance
Wisconsin Manufacturing Company will be mak-
ing money for the stockholders once sales have
passed the $2,112,600 mark; under the budget
schedule proposed by the department heads, by
contrast, tfie company will not be over the hump
until sales pass the $2,670,600 mark, which puts
the company in a precarious position if sales fall
below expectations.
When these different groups of figures are
obtained, they can be listed in some such form
as
E X H I B IT I ,
which shows the breakeven point
analysis of the proposed departmental budgets
for Wisconsin Manufacturing Company.
Interpreta t ion of Analys is
Now, what does this analysis tell manage-
me nt? From it, top executives can see at a glance
that the greatest
relative
increases in proposed
costs lie in administrative expense and factory
overhead, the next greatest in selling expense,
and the next in prime material. (Th e largest
increases
doUarwise
are, of course, in factory
overhead and prime material; on this basis,
the jump in selling expense does not show up as
being as significant as it is, at least from the
standpoint of corrective management action.)
Top management's interpretation of the soft
spots in the cost picture is not distorted by
volum es. Using an objective, readily agreed-on
frame of reference, management can discuss
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Ha rvard usiness Review
heads. There
can
beabetter meetingof
the
mindsonwha tto
do and why
to do it. For
instance,
let us
suppose that
we are in the
shoes
of Wisconsin's management. We might find
ourselves thinking this
way:
After reviewing overhead practices
and
overhead
organizationasthe first stepin finding opportu-
nities
to
reduce excesses
in
factory overhead,
fac-
tory management tells
us
that overhead increases
have come about largely
as a
result
of
fringe bene-
fits for labor.
Do we
takeitlying down?
On the
contrary; our engineering and methods men can
computationsand findout what items accountfor
the variation between breakeven performance and
the budget request.
Any
item taken
by
itself
may
seem small,
but
that
is no
reason
for
overlooking
it.
It
is
much easier
to
coordinate
the
thinking
of de-
partment heads, andtoimpress them withthe
corrosive action
on
profits, when eost excesses
are
as small
as 3% or 4%.
Alternat ive Coursesof Action
Of course,itmay be found that the costin-
creasesare not all related to departmental per-
formance. For example,the profit deterioration
EXHIBIT
I.
BREAKEVEN POINT ANALYSIS
OF
PROPOSED DEPARTMENTAL BUDGETS,
WISCONSIN MANUFACTURING COMPANY
Net sales
Cost
of
sales
Direct labor
Prime material
Factory overhead
Total
Gross Profits
Expense
Selling
Administrative
Total
Total costs
Net profit (before taxes)
Breakeven point
in net
sales
for the
year*
Profit pickupt
reakeven factors
Standby costs
per year
294,000
294,000
100,000
84,500
184,500
478,500
Variable costs
per
100n t
sales
$10.Bo
46.80
12.10
69.70
7-27
0.38
$7.65
$77.35
$22.65
reakeven
performance
2,700,000
291,600
1,263,600
620,700
2,175,900
524,100
296,290
94,760
391,050
$2,566,950
133,050
2,1 12,600
budget
requests
2,700,000
291,600
1,296,044
689,536
2,277,180
422,820
310,953
106,267
417,220
2,694,400
5,600
2,670,600
$ 18.86
Control
figures
100%
9 7 %
9 0 %
9 6 %
9 5 %
8 9 %
9 4 %
9 5 %
* Breakeven point is calculated bydividing total standby costsby profit pickup; since the control figure indicates95%
realization, total standby costs must
be
adjusted accordingly ($478,500 -
95%)
before breakeven pointisfoundfor
departmental budget requests.
t Profit pickup represents difference between $100 and total variable cost per $100 net sales (adjusted by control
figure if called for).
push forelimination ofprime labor costs
and
for greater mechanization; the whole bag
of
tricks
usedtoaccomplish cost reduction canbebrought
into play.
*
Selling and administrative cost increases cannot
be allowed
to
go scot-free,ifonly
for
the psycho-
logieal effect
on the
restof
the
organization. It
may be that we are getting fancy in these depart-
ments, or have added things nice to have. There
must be assurance that value for the money will be
realized inabetter competitive position or in future
returns which cannot
be
expected
to be
realized
in the forecasted period. Even so, suchanassur-
ance for thefuture isnot analibifortakingit
easy now. How much can werecover with less
costly paper work? What
can we
drop
to
make
up for the additions we cannot or should not avoid?
We decide to go to the standby and variable cost
may
be
attributabletoachangein
the mix of
products from long-margin
to
short-margin lines
(a situation whichIshall discuss
in
detail later)
or
to
fundamental changes
in the
business. Such
findings call
for
real exerciseofthat
art
called
management. The topexecutives of
Wis-
consin Manufacturing Company will needto
look cold-bloodedly atthe risks involved
and
reach
a
positive decision. That decision
may
call
for anything from cautious acceptance
to
highly
aggressive action. He re
are
some
of the
specific
ways
in
which
top
management thinking might
react
to the
breakeven point analysis:
C
We
must challenge ourselvesto
no
longer
accept budget estimates on the grounds that 'our
department heads know what they
are
about
or
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they wouldn'tIbe where they are.' Though this
attitude
is
harji
to pin
down,
it is
none
the
less
positive
in its
effect
on the
breakeven point
and on
profits. We a e letting the breakeven point rise
nearlyto our jjrobable volume. Can we be sound
and do so?
C "Our original breakeven point
of
$2,112,600
is78% of the forecasted volumeof $2 ,700 ,000 .
In
the
probabU economic weather this
is the
mini-
mum margin
of
safety. Hence
we
must instruct
department hqads that the old breakeven point
mustbemaintained and noexpense whichcan be
eliminated or deferred can remain in their plans,
for
the
projected breakeven point
is
excessive."
C We are now forced to pay the piper for
neglect
in
prior years.
The
excesses will
be ac-
cepted only
to the
extent that they
are
temporary.
Immediately
vf e
'build fences' around the tempo-
rary excesses
-^ as
variable excesses over
the old
breakeven point, asprojects to be accounted for.
The time zoning
of the
projects
is
scheduled,
the
progress checked,
and
clear understanding estab-
lished that whentheprojectiscompletedorproved
ineffective, thecost m ustbeeliminated. The tem-
porary risein jthe breakeven point is thus insured
as much
as
possible against becoming other than
temporary."
(Incidentally, this
is
probably
the
toughest type
of action to carry through |p a successful conclu-
sionbut a very effective methodinbreakevencon-
trol.
It is
also
an
appropriate course following
a
management C(i)nclusion that
the
planned excesses
are good risks
f|or
greater gains
in the
future.")
C
The
perjformance excesses
are not
true
ex-
cessesat all, butratheranincreasein organization
capacity; and rwe have already invested in some
training. To pay for these excessesand to main-
tain
the
same relative breakeven point, sales volume
must
be
forced; upward
to
$3,450,000 (where
the
profits on the revised breakeven point will equal
the profits on the old breakeven point) without
added capital expenditure. The challenge is to
our sales department.
Can our
sales department
show
us
that
it can get
$750,000
of
volume above
its original forecast without capital plant expendi
tureandwithout shortening themarginon any of
our products?"
"None of these actionscan be the solean-
swer,
and we
must employ different approaches
in
combination.
For
instance, half
the
excess
we ac-
cept, and half;must be made goodby extra sales
volume. Or, vi e accept half the projects
if
addi-
tional volume cjan
be
found
to
cover
the
rest
of the
excesses. In aijiy event,wepredicateall ourdeci-
sions
on
answers
to
such questions
as: Do our
plans maintain
the
same relative
(not
necessarily
the same absoliite) breakeven point? Does
the re-
reakeven Point Control
127
sultant variable profit pickup rate represent nearly
the same profit above
the
breakeven point? W ill
the realizable profits be an adequate return on
capital employed and on all the extra workand
riskswe must undertake?"
Unexpected Situations
In practice, the forecasts on which the break-
even point analysis is based will need to be re-
vised from time to time. One of the beauties of
breakeven point control is that it lends itself
easily to management's needs for fresh plan-
ning when unexpected situations occur. Using
Wisconsin Manufacturing Company again as a
case example, let us tum now to three such
situations and examine their implications in
terms of the company's profit outlook. What
happens to the breakeven point if the company
gets $2,700,000 sales as forecasted, but there
is a greater proportion of sales for low-margin
products than expected? What happens if the
forecasted volume does not materialize? What
is the effect of performance failures on the part
of operating departments?
Less Profitable Sales
In a business or division of a business having
three product lines, there may be one with a
normal 10% gross margin, another with a nor-
mal 20% gross margin, and still another with
a normal 30% gross margin. Past experience
may indicate or management may plan that each
product line should make up, say, one-third of
total sales volume. With such a product mix,
the average gross margin for the company would
be 20%. In one month, however, the 30%
line may make up 50% of the total business;
in another month the same line may make up
but 10% of the total. Such swings in sales can
extinguish profits or handsomely augmentprof-
its even though total billings remain constant.
Unless isolated and measured, changes in the
sales mixture confuse profit control and under-
standing. To. illustrate:
As previously indicated,
the
12-month sales
forecast for the Wisconsin Manufacturing Com-
pany is $2 ,70 0,0 00 . Broken down by product
lines
the
forecast
is
$1,215,000
for
Product
A,
$675,000
for
Product B,
and
$810,000
for
Prod-
uct
C.
Suppose that during
the
forecasted period
the total sales
do not
change materially
but
sales
of ProductsA and C are reversed, thereby increas-
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to $78.14
per $100.
What difference will this
make
in the
calculations
of
profits
and the
break-
even point?
The increase
of the
variable cost amounts
to
$0.79
per $100 of
sales.
On the
basis
of
$2,700,-
000 sales
per
year,
the
resulting loss
of
profits
would
be
$21,330 ($2,700,000
X
$0.79
per
$1 00 ). Th is loss increases
the
breakeven point
from
$2,r
r2,6oo
net
sales
per
year
to
$2,188,900
($478,500
-^
$21.86
per
$100).
Less Volume
As every policy-making executive realizes,
volume plays
a
tremendous part
in
profit
mak-
ing;
at the
same time, executives often fail
to
risesandfalls with volume. He isalways
on notice when curtailment
is
necessary
or ex-
pansion
is
reasona ble. Responsibility
for man-
aging
his
share
of the
business
is
fixed
and de-
fined in terms
of
cost dollars
in
advance
of the
change. Because
of
this, tbere
is
less
of
that
arbitrary
nature
of
pressure from above wbich
leads
to
hu m an relation s difficulties.
To illustrate
the
effect
of
volume changes
on
a variable budget,
let us
suppose that
the
sales
forecast
for the
Wisconsin Manufacturing
Com-
pany
has to be
revised down ward
to
$2,400,000
(with
the
same proportionate drops
for
Products
A,
B, and C). The
implications
for
costs
and
profits might
be
summarized
as in
EXHIBIT II.
E X H I B I T II . SU MMA R Y OF E FFE C TS U N D E R R E V ISE D SA LE S FO R E C A ST,
W I S C O N S I N
M A N U F A C T U R IN G C O M P A N Y
Product
product B
Product C
Total
Revised projected sales $1 ,08 0,0 00
Percentageof salestototal 4 5
Variable costs
per $100
net sales $79 -37
Total costs
(including standby) $1, 019 ,936
Profit (-h) or loss ( - )
before taxes
-I-
$60,064
6OO,OOQ
2 5 %
64.91
531,560
68,440
720,000
3 0 %
84 66
783,272
- 63,272
5> 4OO OOO
100%
$77-35
$2,334,768
+ $65,232
take changes
in
volume fully into account when
looking
at
fiuctuations
in tbe
rate
of
profit.
To
management
a 16%
profit rate
may
seem fabu-
lous when compared with
the
rate
in
past years
because
the
lower volumes
of
past years
are
partly overlooked.
In
evaluating
a
rate
of
profit,
more attention needs to be focused on the effi-
ciency of operations producing it. Would rea-
sonably efficient operations have produced a
10%
rate
or a 30%
rate? Th is
is the
important
question.
If
top
man agem ent will take this tougher
point
of
view toward profits,
it
will find that
tbe conventional system
of
budgeting offers
at
best
a
very inadequate method
of
keeping
the
company organization responsive
to
changes
in
sales volume. Un der
a
static forecast
the im-
pulse
for a
reduction
of
spending rates must
come from
the top,
because each depa rtmen t
head takes
his
static expense forecast
as a
license
independent
of
volume declines.
If
volume
in-
creases,
he
knows that
be can
always
get
more
money.
By contrast,
the
variable allowance
in
each
department head's budget automatically breathes
The newly projected profit
of
$65,232 shown
above represents
a
drop
of
$67,818 from
the
projected profit
for
$2,700,000 sales shown
in
EXHIBIT I. (TO check this figure, merely multi-
ply
the
reduction
in
sales
by the
profit pickup
per
$100 of
sales: $30 0,000
X
$22.65
per $100
- $67,95 0.) Even then, managem ent must
re-
duce variable costs
by
more than $232,000
(ob-
tained
by
multiplying
the
decline
in
sales
of
$300,000
by the
variable cost figure
of
$77.35
per
$100 of
sales),
or the
decline will be sharper.
T he new budget indicates exactly what the ex-
ecutives
in
charge
of
Products
A, B, and C
respectively must do if this cost reduction goal
is
to be
achieved.
Measur ing Per formance
T he
new
budget will obviously
be of no
avail
unless
top
management follows through with
ad-
ministrative action. When actual costs
go
above
budgeted costs
when performance does
not
measure
up
management m ust trace
the
vari-
ations
to the
operating departments where
cor-
rections
can be
made.
It can use the
breakeven
analysis
as an
effective educational device
in
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helping depai-tment executives to understand
the company's point of view. To illustrate:
The standbjt and variable allowance for the fac-
tory is budgeted at $49,392 per month, but sup-
pose that in the first month the factory actually
spends $5 4, 14 6. Its 9 1 % realization of break-
even performance thus accounts for an increase of
$4,754 in costs.
What effect does this variation have on the
company's breakeven point? Management can let
the factory suplerintendent and his assistants figure
it out for themselves: The forecasted pickup in
E X H I B I T HI. SUMM ARY OF ALL VARIATIONS
F R OM
F OR ECAS T
Q N PR O FIT A N D
LOSS
S T A T E M E N T ,
W I S C O N S I N M A N U F A C T U R I N G C O M P A N Y
Sales
Product
:
Product B
Product C
Total :
Forecasted costs of sales
Labor -
Material
Overhead
Total
Actual sales less fore-
casted costs
Variations from fore-
casted costs
Material price variation '.
Freight variatiian
Underabsorbed overhead
Due to volume"
Due to 91 % realization
of breakeven
performance
Loss due to mixt
Total
Total actual cost of salesj
Gross profit
Increase in fofecasted
breakeven pOint
Ne t
Forecasted
$ 87 ,300 .00
99,700 .00
58,000.00
$245,000 .00
24,^04 ,60
98,584 .50
51,781.90
$ 1 075.50
117.50
3 210.00
4.754-74
1 207.38
sales
Actual
$ 90 ,606 .00
92,258 .00
42,750 .00
$225,614 .00
174,671 .00
$ 50,943.00
10,365.12
185,036.12
$ 40,577-88
$ 45 ,800 .00
* Since volume was lower than forecasted, productivity
was also lower with a resulting increase in cost.
t Th e actual distribution of sales among products dif-
fered from, the forecast.
Total forecasted costs of sales plus total costs of varia-
tions from forecasted costs.
Loss of profits of $ 10 ,3 65 .1 2 -f- p rofit picltu p of
$22.65 per $100 net sales.
profits above the breakeven point in the company
is $2 2.6 5 ps^ ^10 0 of net sales. Since the costs
are in excess of (he breakeven allowance by $ 4, 75 4,
as determined ijy the standby and variable factors,
it would take $21,000 more monthly sales to break
even than the e3(:isting budge t calls for. On a yearly
basis this means that the annual breakeven point
Breakeven Point Control 129
of the company would be raised from $2 ,112 ,600
net sales to $ 2,3 64 ,60 0. By this method is a fore-
cast watched, controlled, and evaluated as the
costs, profit, and breakeven point planned become
a reality.
Other divisions of the company, of course,
will exceed (and undercut) their budgets, too.
The variations can be recorded in summary
form, together witb sales results, on the profit
and loss statement to show the cumulative ef-
fect on the breakeven point and on net profits,
a s i n EX H I B I T H I .
Conclusion
Onee decision-making executives understand
breakeven point control, they will find that the
difficulty they have had in the past of separating
out the effects of time factors and variable ele-
ments of eost will diminish. No longer will they
be uncomfortable or mute, because they will
understand how simply performance, volume,
and change of mix can be unwoven from the
fabric of an over-all profit and loss statement.
They will also find that they can use breakevens
further to challenge nearly any dollar-and-cents
decision th at afFects th e que stion of profits. For
example:
If capital requirements are broken down into
their standby and variable components in the same
manner as production costs, and if proposed capi-
tal expenditures are viewed in terms of the changes
they produce in the breakeven point, management
can make decisions as to where to spend money in
order to reduce costs on a strictly scientific, cold-
blooded basis.
Proposed changes in selling prices can be
quickly read in terms of their efEects on tbe break-
even point, thus enabling management to deter-
mine in a few minutes how much business must
be added or can be sacrificed to maintain existing
profits.
Breakeven point analysis is also useful in
making valid comparisons of the company's per-
formance with that of competitors. Such compari-
sons are difficult to make under static methods of
accounting as refiected in the profit and loss state-
ment; but once management knows its own break-
even points, it can readily determine comparable
breakeven points for any competitor who publishes
a financial report.
Thus, in many ways can breakeven point con-
trol furnish clues to good or bad cost perform-
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130
Harvard Business Review
ance . In each case, the problem is eventually
one of segregating the good results from tbe
bad by measuring from an approved point just
where it is that the forecasted sales rise above
the forecasted costs.
Naturally management will need to look be-
neath the figures, for poor departmental per-
formance can distort breakeven plans. W he re
to start to correct a disintegrating breakeven
point is often debatable and depends on the
viewpoint; it becomes a ma tter of W bich comes
first, the chicken or the egg? Are th e figures
off, or performanc e or both? Yet the basic
principles and philosophy of breakeven point
control are helpful even with this problem; they
can haul themselves up by their own boot-
straps. They enable executives to be just a
little more discerning in fighting an old and
constant problem, because budget plans are
anchored to one set of conditions and analyses
are not distorted by changing volumes.
Breakeven point control not only contributes
to a more penetrating understanding of m anage-
ment problems, but leads to the development of
a faster-moving, more aggressive executive team.
When incoming figures refiecting departmental
performance have direct, clear implications in
terms of profits, m anagem ent is more inclined to
get tough-mind ed, to hu nt vigorously for ways
to improve performance, and to flush out the
problems that lie hidden in the brush of easy
times. And when the incoming figures have im-
mediate significance, when it is not necessary to
wait and see wh at they mean, there is every
incentive for executives to be on their feet using
foresight rather than in tbeir seats using hind-
sight. M anagem ent can move and move fast
as
things happ en, no t after.
C Readers may be interested to know tha t the
HARVARD BUSINESS REVIEW
has published a number of leading articles on other aspects of management
control:
Chris Argyris, Human Problems with Budgets (January-February 1953)
John BichaidCmley, A Tool for Manag ement Control Maxch
1951)
Arnold F. Emc h, Control Means Action (July-August 1954)
William T. Jerome III, Internal Au diting as an Aid to Managem ent (March-April 1953}
James L. Peirce, The Budget Comes of Age (May-Jime 1954)
Raymond Villers, Control and Freedom in a Decentralized Company (March-April
1954)
A complete set of reprints of the above articles, plus the one in this issue by
Mr. Gardner, can be obtained for $2.00 from Reprint Department,
HARVARD
BUSINESS
R E V I E W ,
Boston 63 , Mass. Please specify the Control Series.
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