An important financial consideration for firms and businesses in the private sector is to be able to determine the level of operation at which they will have maximum profit on their investments or earn just enough income to break even. A government does not operate to maximize profit, but it is just as important for a government to know in advance the level of operation at which a project or activity will be economically and financially viable so that it will not overproduce or undergo a revenue loss. However, to determine the level at which an operation will be viable, one must be able to measure the costs and returns associated with it in precise monetary terms. But for a majority of public goods and services, with the exception of those considered as proprietary or enterprise goods, it is difficult to measure the costs and returns in precise monetary term because of the characteristics that separate them from private goods and services. Nonetheless, where it is possible to measure the costs and returns with some degree of precision, efforts should be made to do so to ensure the viability of a government activity.
This chapter presents four simple yet useful tools of cost analysis that have received considerable attention in the literature on cost studies in recent years: break- even analysis, differential cost analysis, benefit-cost analysis, and cost-effectiveness analysis. Of these, break-even analysis has been extensively used in business and benefit-cost analysis in government. In fact, all four techniques can be used in varying degrees to determine the level of operation at which a given project or activity will be economically and financially viable.
Developed originally by Rautenstrausch in the late 1930s, break-even analysis is considered as one of the most popular techniques used in cost analysis. 1 Its purpose is to integrate the cost, revenue, and output of an activity in order to determine the effect it will have on alternative courses of action. The basic objective is to find, for