breakeven point control for higher profits

7/26/2019 Breakeven Point Control for Higher Profits

1/9

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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124

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.


3/9

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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126

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


5/9

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-


6/9

128

Harva rd usiness Review

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


7/9

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-


8/9

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.


9/9

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