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A critical evaluation and test of break-even analysis as a technique for profit planning Lim, Say Chong

Abstract

This study provides a critical evaluation of break-even analysis in terms of its assumptions and uses and also in terms of the economic theory of the firm in the short and long run and under perfect and imperfect competitive conditions. It also includes a test of the hypothesis that break-even analysis can be better than the percentage of sales method as a technique for forecasting the future operating profits of firms and the null hypothesis that there is no difference between break-even analysis and the percentage of sales method as a technique for forecasting the future operating profits of firms. The test is based on data (without adjustments) from Moody's Industrial Manuals. Although the break-even approach is more sophisticated and requires more time, effort and expense, the test shows that at the 0.01 level of significance, there is no difference between the accuracy of its forecasts of operating profits and that of the percentage of sales method. The hypothesis is therefore rejected and the null hypothesis accepted. The conclusion drawn from the test is that the management of a firm should not make use of break-even analysis to forecast its operating profits if it is not prepared to make any adjustments to its data to recognise the effects of changes in the determinants (excluding volume) of profits. The percentage of sales method should be used instead.

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