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BILL FRENCH
Bill French picked up the phone and called his boss, Wes Davidson, controller of Duo-Products Corporation. Wes, Im all set for the meeting this afternoon. Ive put together a set of break-even statements that should really make people sit up and take notice and I think theyll be able to understand them, too. After a brief conversation, French concluded the call and turned to his charts for one last checkout before the meeting. French had been hired six months earlier as a staff accountant. He was directly responsible to Davidson and had been doing routine types of analytical work. French was a business school graduate and was considered by his associates to be quite capable and unusually conscientious. It was this later characteristic that had apparently caused him to rub some of the working folks the wrong way, as one of his coworkers put it. French was well aware of his capabilities and took advantage of every opportunity that arose to try to educate those around him. Davidsons invitation for French to attend an informal managers meeting had come as a surprise to others in the accounting group. However, when French requested permission to make a presentation of some break-even data, Davidson acquiesced. Duo-Products had not been making use of this type of analysis in its planning procedures. Basically, what French had done was to determine the level at which the company must operate in order to break even. As he put it, The company must be able at least to sell a sufficient volume of goods so that it will cover all the variable costs of producing and selling the goods. Further, it will not make a profit unless it covers the fixed costs as well. The level of operation at which total costs are just covered is the break-even volume. This should be the lower limit in all our planning. The accounting records had provided the following information that French used in constructing his chart: Plant capacity 2 million units per year Past years level of operations 1.5 million units Average unit selling price - $7.20 Total fixed costs - $2,970,000 Average unit variable cost - $4.50 From this information French observed that each unit contributed $2.70 to fixed costs after covering its variable costs. Given total fixed costs of $2,970,000, he calculated that 1,100,000 units must be sold in order to break even. He verified this conclusion by calculating the dollar sales volume that was required to break even. Since the variable costs per unit were 62.5

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percent of the selling price, French reasoned that 37.5 percent of every sales dollar was left available to cover fixed costs. Thus, fixed costs of $2,970,000 required sales of $7,920,000 in order to break even. When he constructed a breakeven chart, his conclusions were further verified. The chart also made it clear that the firm was operating at a fair margin above break-even, and that the pretax profits accruing (at the rate of 37.5 percent of every sales dollar over break even) increased rapidly as volume increased (see Exhibit 1 at p. 2). Shortly after lunch, French and Davidson left for the meeting. Several representatives of the manufacturing departments were present, as well as the general sales manager, two assistant sales managers, the purchasing officer, and two people from the product engineering office. Davidson introduced French to the few

people whom he had not already met, and then the meeting got under way. Frenchs presentation was the last item on the agenda. In due time the controller introduced French, explaining his interest in cost control and analysis. French had prepared copies of his chart and supporting calculations for everyone at the meeting. He described carefully what he had done and explained how the chart pointed to a profitable year, dependent on meeting the sales volume that had been maintained in the past. It soon became apparent that some of the participants had known in advance what French planned to discuss; they had come prepared to challenge him and soon had taken control of the meeting. The following exchange ensued (see Exhibit 2 for a list of participants and their titles):

Exhibit 1. Break-Even Chart Total Business

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Exhibit 2. List of Participants in the Meeting Bill French................................. Wes Davidson........................... John Cooper.............................. Fred Williams............................ Ray Bradshaw........................... Arnie Winetki............................. Anne Fraser.............................. Staff Accountant Controller Production Control Manufacturing Assistant Sales Manager General Sales Manager Administrative Assistant to President

John Cooper: You know, Bill, Im really concerned that you havent allowed for our planned changes in volume next year. It seems to me that you should have allowed for the sales departments guess that well boost unit sales by 20 percent. Well be pushing 90 percent of capacity then. It sure seems that this would make quite a difference in your figuring.

Bill French: That might be true, but as you can see, all you have to do is read the cost and profit relationship right off the chart for the new volume. Lets see at a million eight-hundred-thousand units wed Fred Williams: Wait a minute, now! If youre going to talk in terms of 90 percent of capacity, and it looks like thats what it will

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be, you had better note that well be shelling out some more for the plant. Weve already got approval on investments that will boost fixed costs by at least $60,000 a month. And that may not be all. We may call it 90 percent of plant capacity, but there are a lot of places where were just full up and we cant pull things up any tighter. John Cooper: Fred is right, but Im not finished on this bit about volume changes. According to the information that Ive got here and it came from your office Im not sure that your break-even chart can really be used even if there were to be no changes next

year. It looks to me like youve got average figures that dont allow for the fact that were dealing with three basic products. Your report on each product lines costs last year (see Exhibit 3) makes it pretty clear that the average is way out of line. How would the break-even point look if we took this on an individual product basis? Bill French: Well, Im not sure. It seems to me that there is only one break-even point for the firm. Whether we take it product by product or in total, weve got to hit that point. Ill be glad to check for you if you want, but

Exhibit 3 Product Class Cost Analysis, Normal Year Aggregate

Sales at full capacity (units) Actual sales volume Unit sales price Total sales revenue Variable cost per unit Total variable cost Fixed costs Profit Ratios: Variable cost to sales Unit contribution to sales Utilization of capacity 2,000,000 1,500,000 $7.20 10,800,000 4.50 6,750,000 2,970,000 1,080,000 0.625 0.375 75%

A
600,000 $10.00 6,000,000 7.50 4,500,000 960,000 540,000 0.75 0.25 30%

B
400,000 $9.00 3,600,000 3.75 1,500,000 1,560,000 540,000 0.42 0.58 20%

C
500,000 $2.40 1,200,000 1.50 750,000 450,000 0 0.625 0.375 25%

Ray Bradshaw: Guess I may as well get in on this one, Bill. If youre going to do anything with individual products, you ought to know that were looking for a big shift in our product mix. The A line is really losing out, and I imagine that well be lucky to hold two-thirds of its volume next year. Wouldnt you buy that, Arnie?

(Agreement from the general sales manager.) Thats not too bad, though, because we expect that we should pick up the 200,000 that we lose, plus about a quarter million units more, in C production. We dont see anything that shows much of a change in B. Thats been solid

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for years and shouldnt change much now. Arnie Winetki: Bradshaws called it about as we figure it, but theres something else here. Weve talked about our pricing on C enough, and now Im really going to push our side of it. Rays estimate of maybe half a million units 450,000 I guess it was increase on C for next year is on the basis of doubling the price with no change in cost. Weve been priced so low on this item that its been a crime weve got to raise it for two reasons. First, for our reputation: the price is out of line with other products in its class and is completely inconsistent with our quality reputation. Second, if we dont raise the price, well be swamped, and we cant handle it. You heard what Williams said about capacity. The way the whole C field is exploding well have to deal with another half-million units in unsatisfied orders if we dont jack the price up. We cant afford to expand that much for this product. At this point, Anne Fraser walked toward the front of the room from where she had been standing near the rear door. The discussion broke for a minute, and she took advantage of the lull to interject a few comments. Anne Fraser: This certainly has been a helpful discussion. As long as youre going to try to get all the things together for next year, lets see what I can add to help you: Number One: Lets remember that everything that shows in the profit area here on Bills chart is divided

almost evenly between the government and us. Now, for last year we can read a profit of about $900,000. Thats right; but we were left with half of that, and then paid out dividends of $300,000 to the stockholders. Since weve got an anniversary year coming up, wed like to put out a special dividend of about 50 percent extra. We ought to retain $150,000 in the business, too. This means that wed like to hit $600,000 profit after taxes. Number Two: From where I sit, it looks as if were going to have negotiations with the union again, and this time its likely to cost us. All the indications are and this isnt public that we may have to meet demands that will boost our production costs what do you call them here, Bill variable costs by 10 percent across the board. This may kill the bonusdividend plans, but weve got to hold the line on past profits. This means that we can give that much to the union only if we can make it in added revenues. I guess youd say that raises your break-even point, Bill and for that one Id consider the companys profit to be a fixed cost. Number Three: Maybe this is the time to think about switching our product emphasis. Arnie may know better than I which of the products is more profitable. You check me out on this Arnie and it might be a good idea for you and Bill to get together on this one, too. These figures that I have (Exhibit 3) make it look like the percentage contribution on line A is the lowest of the bunch. If were losing volume there as

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rapidly as you sales folks say, and if were as hard pressed for space as Fred has indicated, maybe wed be better off grabbing some of that big demand for C by shifting some of the assets from A to C. Wes Davidson: Thanks, Anne. I sort of figured that wed wind up here as soon as Bill brought out his charts. This is an approach that weve barely touched on, but, as you can see, youve all got ideas that have to be made to fit here somewhere. Let me suggest this: Bill, you rework your chart and try to bring into it some of the points that were made here today. Ill see if I can summarize what everyone seems to be looking for. First of all, I have the idea that your presentation is based on a rather important series of assumptions. Most of the questions that were raised were really about those assumptions. It might help us all if you try to set the assumptions down in black and white so that we can see just how they influence the analysis. Then, I think that John would like to see the unit sales increase

factored in, and hed also like to see whether theres any difference if you base the calculations on an analysis of individual product lines. Also, as Ray suggested, since the product mix is bound to change, why not see how things look if the shift materializes as he has forecast? Arnie would like to see the influence of a price increase in the C line; Fred looks toward an increase in fixed manufacturing costs of $60,000 a month; and Anne has suggested that we should consider taxes, dividends, expected union demands, and the question of product emphasis. I think that ties it all together. Lets hold off on our next meeting until Bill has had time to work some more on this. With that, the meeting disbanded. French and Davidson headed back to their offices and French, in a tone of concern, asked Davidson, Why didnt you warn me about the hornets nest I was walking into? Bill, you didnt ask!

Questions 1. What are the assumptions implicit in Bill Frenchs determination of his companys break-even point? 2. On the basis of Frenchs revised information, what does next year look like: a. What is the break-even point?

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b. What level of operations must be achieved to pay the extra dividend, ignoring union demands? c. What level of operations must be achieved to meet the union demands, ignoring bonus dividends? d. What level of operations must be achieved to meet both dividends and expected union requirements? 3. Calculate each of the three products break-even points using the data in Exhibit 3. Why is the sum of these three volumes not equal to the 1,100,000 units aggregated break-even volume? 4. Is this type of analysis of any value? For what can it be used?

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