Break-Even and Contribution Analysis as a Tool in Budgeting
The budgeting process is the manager’s primary tool for dealing with future uncertainty. In developing a period budget, managers must make certain assumptions of cause and effect: “Unit sales will increase 10 percent because of overall demand for the product, assuming that sales prices can be held to a 5 percent increase.” “Gross profit percentage can be maintained despite a 6 percent increase in purchase costs.” “Sales demand will hold steady unless there is a war in Abyssinia.”
Although they cannot do anything about Abyssinian affairs, managers can, to some degree, influence purchase costs, sales volume, and selling prices. How well they understand their relationship and the effect on the enterprise will largely determine the effectiveness of the business plan. This chapter describes the relationship of cost, volume, and price as well as certain techniques for integrating these considerations into the budgeting process.
Perhaps the best way to understand the cost–volume–price relationship is to examine the technique commonly referred to as break-even analysis. The name is unfortunate. Except for certain situations, such as the start-up of a new business or the determination of when to pull the plug on losing operations, managers are not particularly interested in pinpointing break-even volume. The planning effort ...