People talk about break-even analysis, but do they have the necessary apparatus in their management accounts to make this metric meaningful?
What it is
The idea of “break-even point” is the number of units needed to be produced and sold for the contribution (“Contribution” in accounting means revenue minus variable cost) generated to cover the fixed costs of the business. In a service business the units of production could be hours sold of advice, number of haircuts given, km driven with clients in a taxi, etc. What you get paid for in terms of “per”, that’s your unit and that’s what your break-even point will be expressed in. It’s not a money measure usually, unless you are doing it for a bank or a foreign exchange counter.
In business which are made up of numerous products and/or services, which are handles in a dissimilar way, the overall break-even point cannot be shown because not everything will be in the same unit of measure. Even when they are, the way in which they are buit up may differ. Where you have a complex organisation you have to find a way to apportion the fixed and the variable costs to individual products or services and even to individual projects. There is not one single approach to how to do that, which is why break-even point is not normally used as a measure to compare one company to another, but
much more frequently as a decision criteria for management within one company, and especially as a “go/no-go” criterion for projects. In Japan, at five o’clock in the afternoon, when deciding to go/no go home, for instance, they could say “o no, gogo no goji no go/nogo desu”, for example. And then stay at work until they can break even on inemuri production.
The biggest hurdle in this is that costs are not always strictly either fixed or variable, you also get step costs, which go up in blocks so that on a graph they look like stairs. The best way to find the break even point is indeed to draw a graph or get Excel to do it, and also bear in mind that with increased volumes there can be a reduction (or sometimes an increase) in marginal cost and revenues. You can also find that a resource needed for the production is limited so that the actual break-even point, that number of units, isn’t achievable. An example of this is where you cannot get another machine and there are simply not enough hours in the day for the machine you have to make the units. And interesting analysis sets out the fixed costs first of all and then works out what the capacity is for this set of fixed costs, you then put the cost and revenue lines in for that range of production volumes. Then you can see if you achieve break-even or not.
Not the be-all and end-all
Break-even analysis is a very useful tool but isn’t the be-all and end-all of management decision making, as Macbethad mac Findláech, a noted Scottish management guru, puts it. It is one weapon in a big arsenal. I knew one manager, who shall remain nameless, who swore by that one metric. Needless to say, you won’t have heard of him even if I were inclined to divulge his identity. He went a bit overboard on this one criterion even though his management accounting wasn’t really geared up to give him the information he needed to find this metric, as a result of which he regularly made sub-optimal decisions and ended up very frustrated and now he makes hamburgers in the park in the summer and goes to sleep at the end of the hamburger season, like a bear, only to awaken and make more hamburgers for park visitors every spring, because he cannot break-even with the numbers of hamburgers people will buy in parks in the winter. Even in Hamburg.
I said to him “Sproey, you are never going to be able to work with this metric unless you first make sure your management accounting is geared up to give you the accurate cost information you need to get to the figure propely. Let me re-design your management accounting plan of accounts and policies, and then the analysis of costs will be what you need”. Had he listened to me then, he would not need to hibernate in the woods for half a year every year now.
The Butcher's Masquerade: Dungeon Crawler Carl, Book 5
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