Agriculture Reference
In-Depth Information
The decision-making process just described is, in itself, a decision tool. But among the more
important decision tools used by agribusiness managers is volume-cost or breakeven analy-
sis. This is because most food and agricultural businesses are relatively capital intensive,
requiring large investments in land, plants, and equipment. The food and agricultural indus-
tries are so seasonal that such large investments in many fi rms can be used only for very
short periods of time, for example during planting or harvesting. The capital-intensive nature
of the industry emphasizes the importance of investment decisions and the effi cient use of
fi xed assets.
The remainder of this chapter is devoted to a discussion of this important management
tool. Volume-cost analysis techniques are discussed and a format for utilizing this tool is
presented. Numerical examples from the fi rm presented in
Chapter 9
—Brookstone Feed
and Grain (BF&G)—will be used to illustrate the use of breakeven analysis and the many
questions this decision tool can help management address.
Volume-cost analysis
Volume-cost analaysis
, or
breakeven analysis
as it is sometimes called, is a tool for exam-
ining the relationship between costs and the volume of business generated by the fi rm. This
tool analyzes differences in the kinds of costs encountered by every agribusiness and how
the volume of business affects them. Volume-cost analysis shows the level of business
necessary to breakeven and/or to earn a specifi c amount of profi t under various cost and
price assumptions.
Volume-cost analysis can show the impact of changes in selling price on the volume of
business necessary to reach a certain profi t level. It can reveal specifi cally how anticipated
cost changes will affect profi t levels. It can be useful in evaluating various marketing
strategies, such as advertising and promotion expenditures, individual product pricing
decisions, and the amount of sales a new salesperson must generate to cover her salary and
other costs.
The basis for volume-cost analysis is the separation of costs into two categories: fi xed
and variable.
Fixed costs
are those costs that do not fl uctuate with the volume of business.
Examples of fi xed costs would be depreciation, interest, and insurance.
Variable costs
are
those costs that change directly with the volume of sales. Examples would include the cost
of goods sold, overtime, and commissions. The key question in classifying costs into these
two classes is whether the cost is
directly
affected by how much is sold. Said another way,
fi xed costs are present regardless of the amount sales. As soon as a business gears up for a
particular level of sales, it incurs a certain amount of expense whether or not it makes any
sales at all. These are fi xed or sunk costs.
On the other hand, some additional expenses are incurred as product is sold. These incre-
mental expenses are not charged to the income statement if the sale is not completed. These
are variable costs. Note that the emphasis is on the sale. The actual sale of a product or serv-
ice is the point of determination for this cost. Even in a manufacturing or processing plant,
where costs are incurred throughout the production process, the crucial point is the actual
sale. Until the sales transaction is completed, no costs are counted as expenses and are there-
fore not included on the income statement. Instead, they remain in inventory and show only
on the balance sheet. If there are no sales during a period, by defi nition, there are no variable
costs. Selling something actually causes the variable costs to be incurred.
Some people tend to confuse variable costs with controllable costs, but they are not
the same things. While some variable costs are controllable by management, others are not.
