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How can management be tough-minded as

to rising costs, flexible as to changing conditions, resourceful as to future planning?

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

each dollar of lost sales, or the breakeven point

will climb to a dangerous level. But how can
management instill cost-consciousness in younger executives who have never experienced the
problems involved in coping with falling volumes, educate them to take a more critical look
at some of those costs that have come to be regarded (however wrongly) as "fixed"? What
can be done about excessive costs due to slowmoving 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 business 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 thinking of the kind of excited, panicky
pressure from above to "cut costs anywhere"
that all too often has characterized management's approach in the past; that may do more
harm than good. Rather, I am thinking 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-all company 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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regardless of whether profits are rising or falling.

In this article I shall discuss the working of
this approach, which I call "breakeven point
control." Let us begin by considering briefly
the need for breakeven point control as opposed
to conventional accounting; then turn to a detailed step-by-step analysis of how and why it
works, relying not on generalities but on specific
figures and a concrete case situation.

Need for Flexible Control

In planning the attack on costs, management
should remember that cost control problems
arise, in the main, because of the fact that executives must plan ahead in time, that they
"deal in futures."
Tbis is so obvious that we are likely to overlook its implications. If all inventory, expenditure, financing, depreciation, investment, and
other problems had time sequences of only one
moment, say, or one month, the difficulties of
management would be minimized. But, unfortunately, the cost decisions that come to management 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 those requiring planning over an extended depreciation
period (for example, an investment in machines
which are capable of producing products now
only on the drawing boards).
It is because of the importance of the time
or "turnover" factor that policy makers often
find accounting so frustrating. Conventional
accounting is an exacting science. It reports in
terms of static conditions, usually after the fact.
It reckons that the company made a given percentage of profit for a given period of time on
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 are used up faster than others,
that some inventories turn over faster than
others. Accordingly, accounting often has very
hmited helpfulness to management in terms of
where actually to turn in order to control costs.

Tbe Breakeven Point

By contrast, the breakeven point
a common 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 first $i,ooo of sales. On
the other hand, if all costs were more or less
constant (which they are not), the breakeven
point would be static, not moving (which it is),
and cost control would be a pretty cut-and-dried
business. But the company has both standby
and variable costs, and it is because of this that
there is a breakeven point. (To me the term
fixed cost is very unsatisfactory, because no cost
is really fixed; ^ I prefer to label expenditures
that continue regardless of production level as
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, "accounting" costs and generalities like "Our costs are x
dollars, so we will have to have y dollars in sales
to get them back," instead of specific, variable
costs. They cannot put breakeven points to their
really important use, which is for budgeting,
forecasting, and controlling costs.
A breakeven point moves witb changing conditions (e.g., fluctuations in sales or in procurement costs) and, in moving, flashes a warning.
If management does not heed that warning and
follow through with appropriate action, the
annual budget and the forecasts on which it is
based soon become obsolete for all practical
purposes especially in years of great economic 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 the past with the present, and both
with the future. Present forecasting methods
too often are unsatisfactory because it is hard
to visualize plans in terms of the actualities of
the past, especially when the volume forecasted
is different from immediate past experiences.
The breakeven approach sharpens the effective^ See, for example, Bruce Payne, "A Program for Cost

October 1953, p. 71.


Breakeven Point Control

ness of forec|asting because the projected figures
can be muclj more intensively analyzed in relation 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 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


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,
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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heads. There can be a better meeting of the

minds on what to 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
organization as the first step in finding opportunities to reduce excesses in factory overhead, factory management tells us that overhead increases
have come about largely as a result of fringe benefits for labor. Do we take it lying down? On the
contrary; our engineering and methods men can

computations and find out what items account for

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 department heads, and to impress them with the
corrosive action on profits, when eost excesses are
as small as 3% or 4 % .
Alternative Courses of Action
Of course, it may be found that the cost increases are not all related to departmental performance. For example, the profit deterioration



Net sales
Cost of sales
Direct labor
Prime material
Factory overhead
Gross Profits
Total costs
Net profit (before taxes)
Breakeven point in net
sales for the year*
Profit pickupt

Breakeven factors
Variable costs
per $100 net sales




















$ 422,820




$ 7-27




$ 7.65










$2,1 12,600



* 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).

push for elimination of prime labor costs and

for greater mechanization; the whole bag of tricks
used to accomplish cost reduction can be brought
into play.
Selling and administrative cost increases cannot
be allowed to go scot-free, if only for the psychologieal effect on the rest of the organization. It
may be that we are getting "fancy" in these departments, or have added things "nice to have." There
must be assurance that value for the money will be
realized in a better competitive position or in future
returns which cannot be expected to be realized
in the forecasted period. Even so, such an assurance for the future is not an alibi for taking it
easy now. How much can we recover 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 attributable to a change in the mix of

products from long-margin to short-margin lines
(a situation which I shall discuss in detail later)
or to fundamental changes in the business. Such
findings call for real exercise of that art called
"management." The top executives of Wisconsin Manufacturing Company will need to
look cold-bloodedly at the risks involved and
reach a positive decision. That decision may call
for anything from cautious acceptance to highly
aggressive action. Here are some of the specific
ways in which top management thinking might
react to the breakeven point analysis:
C "We must challenge ourselves to no longer
accept budget estimates on the grounds that 'our
department heads know what they are about or

Breakeven Point Control


they wouldn't Ibe 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
nearly to our jjrobable volume. Can we be sound
and do so?"

sultant variable profit pickup rate represent nearly

the same profit above the breakeven point? Will
the realizable profits be an adequate return on
capital employed and on all the extra work and
risks we must undertake?"

C "Our original breakeven point of $2,112,600

is 78% of the forecasted volume of $2,700,000.
In the probabU economic weather this is the minimum margin of safety. Hence we must instruct
department hqads that the old breakeven point
must be maintained and no expense which can be
eliminated or deferred can remain in their plans,
for the projected breakeven point is excessive."

Unexpected Situations

C "We are now forced to pay the piper for

neglect in prior years. The excesses will be accepted only to the extent that they are temporary.
Immediately vf.e 'build fences' around the temporary excesses -^ as variable excesses over the old
breakeven point, as projects to be accounted for.
The time zoning of the projects is scheduled, the
progress checked, and clear understanding established that when the project is completed or proved
ineffective, the cost must be eliminated. The temporary rise in jthe breakeven point is thus insured
as much as possible against becoming other than
(Incidentally, this is probably the toughest type
of action to carry through |p a successful conclusion but a very effective method in breakeven control. 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 excesses at all, but rather an increase in organization
capacity; and rwe have already invested in some
training. To pay for these excesses and to maintain 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 expenditure and without shortening the margin on any of
our products?"
"None of these actions can be the sole answer, and we must employ different approaches in
combination. For instance, half the excess we accept, and half;must be made good by extra sales
volume. Or, vi^e accept half the projects if additional volume cjan be found to cover the rest of the
excesses. In aijiy event, we predicate all our decisions on answers to such questions as: Do our
plans maintain! the same relative (not necessarily
the same absoliite) breakeven point? Does the re-

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


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to $78.14 per $100. What difference will this

make in the calculations of profits and the breakeven 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
$100). This 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 making; at the same time, executives often fail to

Revised projected sales

Percentage of sales to total
Variable costs per $100
net sales
Total costs
(including standby)
Profit (-h) or loss ( - )
before taxes

rises and falls with volume. He is always

on notice when curtailment is necessary or expansion is reasonable. Responsibility for managing his share of the business is fixed and defined 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 human relations difficulties.
To illustrate the effect of volume changes on
a variable budget, let us suppose that the sales
forecast for the Wisconsin Manufacturing Company has to be revised downward 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.


Product A

product B

Product C












-I- $60,064

j- $68,440

- $63,272

+ $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 fabulous 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 efficiency of operations producing it. Would reasonably efficient operations have produced a
10% rate or a 30% rate? This is the important
If top management 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. Under a static forecast the impulse for a reduction of spending rates must
come from the top, because each department
head takes his static expense forecast as a license
independent of volume declines. If volume increases, he knows that be can always "get more
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 multiply the reduction in sales by the profit pickup
per $100 of sales: $300,000 X $22.65 per $100
- $67,950.) Even then, management must reduce variable costs by more than $232,000 (obtained 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.
The new budget indicates exactly what the executives in charge of Products A, B, and C
respectively must do if this cost reduction goal
is to be achieved.
Measuring Performance
The new budget will obviously be of no avail
unless top management follows through with administrative action. When actual costs go above
budgeted costs when performance does not
measure up management must trace the variations to the operating departments where corrections can be made. It can use the breakeven
analysis as an effective educational device in

Breakeven Point Control

helping depai-tment executives to understand
the company's! point of view. To illustrate:
The standbjt and variable allowance for the factory is budgeted at $49,392 per month, but suppose that in the first month the factory actually
spends $54,146. Its 9 1 % realization of breakeven 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

Product A
Product B
Product C
Forecasted costs of sales
Actual sales less forecasted costs
Variations from forecasted costs

:$ 87,300.00

$ 90,606.00

-% 24,^04,60

Material price variation '.$

Freight variatiian
Underabsorbed overhead
Due to volume"
Due to 91 % realization
of breakeven
Loss due to mixt
Total actual cost of salesj
Gross profit
Increase in fofecasted
breakeven pOint

$ 50,943.00

$ 40,577-88
$ 45,800.00

* Since volume was lower than forecasted, productivity

was also lower with a resulting increase in cost.
t The actual distribution of sales among products differed from, the forecast.
X Total forecasted costs of sales plus total costs of variations from forecasted costs.
Loss of profits of $10,365.12 -f- profit picltup of
$22.65 per $100 net sales.

profits above the breakeven point in the company

is $22.65 ps^ ^100 of net sales. Since the costs
are in excess of (he breakeven allowance by $4,754,
as determined ijy the standby and variable factors,
it would take $21,000 more monthly sales to break
even than the e3(:isting budget calls for. On a yearly
basis this means that the annual breakeven point


of the company would be raised from $2,112,600

net sales to $2,364,600. By this method is a forecast 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 effect on the breakeven point and on net profits,

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
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
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-


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 beneath the figures, for poor departmental performance can distort breakeven plans. Where
to start to correct a disintegrating breakeven
point is often debatable and depends on the
viewpoint; it becomes a matter of "Wbich comes
first, the chicken or the egg?" Are the figures
off, or performance 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 bootstraps." 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 management 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, management is more inclined to
get "tough-minded," to hunt 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 immediate significance, when it is not necessary to
"wait and see" what they mean, there is every
incentive for executives to be on their feet using
foresight rather than in tbeir seats using hindsight. Management can move and move fast
as things happen, not after.

C Readers may be interested to know that the HARVARD BUSINESS REVIEW

has published a number of leading articles on other aspects of management
Chris Argyris, Human Problems with Budgets (January-February 1953)
John BichaidCmley, A Tool for Management Control (Maxch 1951)
Arnold F. Emch, Control Means Action (July-August 1954)
William T. Jerome III, Internal Auditing as an Aid to Management (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

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."

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