Chapter 2: Break Even Decisions

Should I start a new business?

Cost-volume-profit analysis uses cost behaviors as the basis for making some important decisions about starting and operating a business. These include break-even points, which are the sales volumes in units or dollars that must be achieved before the “downside” risk is covered. The risk of beginning a new venture usually involves significant investments in capital assets—as an example, consider the cost of building an auto assembly line. These costs are considered “fixed” inasmuch as they have the following characteristics:

An idealized fixed cost function can be represented as a horizontal line on an x–y graph, showing that the relationships between costs (y-axis) and quantity (x-axis) is the same in total, regardless of the level of activity. But note that the unit fixed costs changes as the quantity changes (i.e., FC ÷ units). Conversely, a purely variable cost function can be seen as a diagonal line originating at the x–y intercept. This means that as the quantity measure increases, so too does the total variable cost; however, the unit variable cost (measured as the slope of the line) remains unchanged. The figure below illustrates these idealized cost functions (Fig. 2.1).