Professional Documents
Culture Documents
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. But whfen sales level off and decline, 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. No matter how much costs
should go down as sales drop, in fact they hardly
ever bebave that way.
The reasons for this are clear. A period during 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 productive efficiency. In addition 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 organization, 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 difficulty when, ^s volume shows signs of slipping,
they try to get costs in line with sales. They see
clearly that i( 70 cents in costs were added for
each dollar of increased volume during the expansion years, 70 cents must be removed for
124
Harvard Business
Review
September-
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 companies and also many whole small companies
find themselves today. Let us suppose that the
management of the Wisconsin Manufacturing
Company, faiced with the necessity of preparing
for rougher weather in competition, turns to
breakeven point control. How will management go abojit drawing up a budget, making an
analysis, and deciding what action to take?
Control Data Needed
To begin, management needs to have certain
kinds of control information. The list might be
developed as follows:
1. Breakeven factors These are the difEerent standby ind variable costs, from direct labor
to administrative expense, as computed by the accountants. 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 $620,700. But part of this cost
is a variable depending on the number of shifts,
on volume ot production, and so forth. The accountants need to isolate the standby portion and
record it separately. When this is done for Wisconsin, 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 net sales. For example, since Wisconsin's net sales forecast is $2,700,000, the variable
cost for factory overhead would be listed as $12.10
125
It needs to be emphasized, of course, that management 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. Departmental budget requests These are
the budget figures submitted for management approval 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 performance figures compare with the proposed departmental budgets. They are best expressed in
percentages, the former divided by the latter. The
lower the percentage, the more unfavorable the
eontrol figure.
5. Breakeven points in net sales The breakeven points are obtained by dividing total standby
costs by the profit pickup (see bottom line of EXHIBIT i). They are key figures for top management
because they point up the soimdness or unsoundness of the cumulative departmental budget requests. To illustrate, with breakeven perfonnance
Wisconsin Manufacturing Company will be making 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 EXHIBIT I, which shows the breakeven point
analysis of the proposed departmental budgets
for Wisconsin Manufacturing Company.
Interpretation of Analysis
Now, what does this analysis tell management? 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. (The largest
increases doUarwise are, of course, in factory
overhead and prime material; on this basis,
per
$100.
the jump in selling expense does not show up as
2. Breakeven performance figures These are being as significant as it is, at least from the
the yardstick figures to be used in judging the prostandpoint of corrective management action.)
posed budgets! of department heads. They are comTop management's interpretation of the soft
puted by simjple arithmetic on the basis of the
spots in the cost picture is not distorted by
breakeven faqtors and the sales forecast. For example, Wiscoiisin's direct labor cost of $10.80 per
volumes. Using an objective, readily agreed-on
$100 of net iales produces a budget allowance of
frame of reference, management can discuss
$291,600 fori a sales forecast of $2,700,000.
budget proposals with the different department
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Harvard Business
Review
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
Breakeven factors
costs
Variable costs
per $100 net sales
year
$10.Bo
46.80
Breakeven
performance
budget
requests
$2,700,000
$2,700,000
$294,000
12.10
291,600
1,263,600
620,700
$294,000
$69.70
$2,175,900
$100,000
84,500
$184,500
$478,500
Control
figures
291,600
1,296,044
100%
689,536
90%
$2,277,180
$ 422,820
96%
97%
524,100
$ 7-27
0.38
296,290
94,760
310,953
106,267
95%
89%
$ 7.65
$77.35
391,050
$22.65
417,220
94%
$2,566,950
$2,694,400
95%
$133,050
$5,600
$2,1 12,600
$2,670,600
18.86
* Breakeven point is calculated by dividing total standby costs by profit pickup; since the control figure indicates 95%
realization, total standby costs must be adjusted accordingly ($478,500 -^ 95%) before breakeven point is found for
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).
127
Unexpected Situations
In practice, the forecasts on which the breakeven point analysis is based will need to be revised from time to time. One of the beauties of
breakeven point control is that it lends itself
easily to management's needs for fresh planning 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 normal 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 augment profits even though total billings remain constant.
Unless isolated and measured, changes in the
sales mixture confuse profit control and understanding. To. illustrate:
As previously indicated, the 12-month sales
forecast for the Wisconsin Manufacturing Company is $2,700,000. Broken down by product
lines the forecast is $1,215,000 for Product A,
$675,000 for Product B, and $810,000 for Product C. Suppose that during the forecasted period
the total sales do not change materially but sales
of Products A and C are reversed, thereby increasing the total variable cost from $77.35 per $100
128
Less Volume
As every policy-making executive realizes,
volume plays a tremendous part in profit making; at the same time, executives often fail to
EXHIBIT II.
product B
Product C
Total
$1,080,000
45%
$6OO,OOQ
25%
$720,000
30%
5>2,4OO,OOO
$64.91
$84.66
$1,019,936
$531,560
$783,272
$2,334,768
-I- $60,064
j- $68,440
- $63,272
+ $65,232
$79-37
100%
$77-35
Sales
Product A
Product B
Product C
Total
Forecasted costs of sales
Labor
Material
Overhead
Total
Actual sales less forecasted costs
Variations from forecasted costs
:$ 87,300.00
99,700.00
58,000.00
:$245,000.00
sales
Actual
$ 90,606.00
92,258.00
42,750.00
$225,614.00
-% 24,^04,60
98,584.50
51,781.90
174,671.00
$ 50,943.00
1,075.50
117.50
3,210.00
4.754-74
1,207.38
10,365.12
185,036.12
$ 40,577-88
$ 45,800.00
129
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 elements 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 that afFects the question 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 capital 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, coldblooded basis.
Proposed changes in selling prices can be
quickly read in terms of their efEects on tbe breakeven point, thus enabling management to determine 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 performance with that of competitors. Such comparisons are difficult to make under static methods of
accounting as refiected in the profit and loss statement; but once management knows its own breakeven points, it can readily determine comparable
breakeven points for any competitor who publishes
a financial report.
Thus, in many ways can breakeven point control furnish clues to good or bad cost perform-
130
C 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 REVIEW, Boston 63, Mass. Please specify the "Control Series."