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Cost-Volume-Profit Analysis: A Managerial Planning Tool

Cost-Volume-Profit Analysis: A Managerial Planning Tool. Sales revenue – Variable expenses – Fixed expenses = Operating income. Using Operating Income in CVP Analysis. Narrative Equation. Using Operating Income in CVP Analysis. Sales (1,000 units @ $400) $400,000

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Cost-Volume-Profit Analysis: A Managerial Planning Tool

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  1. Cost-Volume-Profit Analysis: A Managerial Planning Tool

  2. Sales revenue – Variable expenses – Fixed expenses = Operating income Using Operating Income in CVP Analysis Narrative Equation

  3. Using Operating Income in CVP Analysis Sales (1,000 units @ $400) $400,000 Less: Variable expenses 325,000 Contribution margin $ 75,000 Less: Fixed expenses 45,000 Operating income $ 30,000

  4. $400,000 ÷ 1,000 $325,000 ÷ 1,000 Using Operating Income in CVP Analysis Break Even in Units 0 = ($400 x Units) – ($325 x Units) – $45,000

  5. Proof Sales (600 units) $240,000 Less: Variable exp. 195,000 Contribution margin $ 45,000 Less: Fixed expenses 45,000 Operating income $ 0 Using Operating Income in CVP Analysis Break Even in Units 0 = ($400 x Units) – ($325 x Units) – $45,000 0 = ($75 x Units) – $45,000 $75 x Units = $45,000 Units = 600

  6. Proof Sales (1,400 units) $560,000 Less: Variable exp. 455,000 Contribution margin $105,000 Less: Fixed expenses 45,000 Operating income $ 60,000 Achieving a Targeted Profit Desired Operating Income of $60,000 $60,000 = ($400 x Units) – ($325 x Units) – $45,000 $105,000 = $75 x Units Units = 1,400

  7. Proof Sales (3,000 units) $1.200,000 Less: Variable exp. 975,000 Contribution margin $225,000 Less: Fixed expenses 45,000 Operating income $ 180,000 (15% of Sales) Targeted Income as a Percent of Sales Revenue Desired Operating Income of 15% of Sales Revenue 0.15($400)(Units) = ($400 x Units) – ($325 x Units) – $45,000 $60 x Units = ($400 x Units) – $325 x Units) – $45,000 $60 x Units = ($75 x Units) – $45,000 $15 x Units = $45,000 Units = 3,000

  8. Or Net income (1 – Tax rate) Operating income = After-Tax Profit Targets Net income = Operating income – Income taxes = Operating income – (Tax rate x Operating income) = Operating income (1 – Tax rate)

  9. After-Tax Profit Targets If the tax rate is 35 percent and a firm wants to achieve a profit of $48,750. How much is the necessary operating income? $48,750 = Operating income – (0.35 x Operating income) $48,750 = 0.65 (Operating income) $75,000 = Operating income

  10. Proof Sales (1,600 units) $640,000 Less: Variable exp. 520,000 Contribution margin $120,000 Less: Fixed expenses 45,000 Operating income $ 75,000 Less: Income tax (35%) 26,250 Net income $ 48,750 After-Tax Profit Targets How many units would have to be sold to earn an operating income of $48,750? Units = ($45,000 + $75,000)/$75 Units = $120,000/$75 Units = 1,600

  11. Sales $400,000 100.00% Less: Variable expenses 325,000 81.25% Contribution margin $ 75,000 18.75% Less: Fixed exp. 45,000 Operating income $ 30,000 Break-Even Point in Sales Dollars First, the contribution margin ratio must be calculated.

  12. Break-Even Point in Sales Dollars Given a contribution margin ratio of 18.75%, how much sales revenue is required to break even? Operating income = Sales – Variable costs – Fixed costs $0 = Sales – (Variable costs ratio x Sales) – $45,000 $0 = Sales (1 – 0.8125) – $45,000 Sales (0.1875) = $45,000 Sales = $240,000

  13. Relationships Among Contribution Margin, Fixed Cost, and Profit Fixed Cost = Contribution Margin Fixed Cost Contribution Margin Total Variable Cost Revenue

  14. Relationships Among Contribution Margin, Fixed Cost, and Profit Fixed Cost < Contribution Margin Fixed Cost Profit Contribution Margin Total Variable Cost Revenue

  15. Relationships Among Contribution Margin, Fixed Cost, and Profit Fixed Cost > Contribution Margin Fixed Cost Loss Contribution Margin Total Variable Cost Revenue

  16. Profit Targets and Sales Revenue How much sales revenue must a firm generate to earn a before-tax profit of $60,000. Recall that fixed costs total $45,000 and the contribution margin ratio is .1875. Sales = ($45,000 + $60,000)/0.1875 = $105,000/0.1875 = $560,000

  17. Multiple-Product Analysis Mulching Riding Mower Mower Total Sales $480,000 $640,000 $1,120,000 Less: Variable expenses 390,000 480,000 870,000 Contribution margin $ 90,000 $160,000 $ 250,000 Less: Direct fixed expenses 30,000 40,000 70,000 Product margin $ 60,000 $120,000 $ 180,000 Less: Common fixed expenses 26,250 Operating income $ 153,750

  18. Income Statement: B/E Solution Mulching Riding Mower Mower Total Sales $184,800 $246,400 $431,200 Less: Variable expenses 150,150 184,800 334,950 Contribution margin $ 34,650 $ 61,600 $ 96,250 Less: Direct fixed expenses 30,000 40,000 70,000 Segment margin $ 4,650 $ 23,600 $ 26,250 Less: Common fixed expenses 26,250 Operating income $ 0

  19. The profit-volume graph portrays the relationship between profits and sales volume.

  20. Example The Tyson Company produces a single product with the following cost and price data: Total fixed costs $100 Variable costs per unit 5 Selling price per unit 10

  21. Profit-Volume Graph Break-Even Point (20, $0) (40, $100) I = $5X - $100 • $100— • 80— • 60— • 40— • 20— • 0— • - 20— • - 40— • -60— • 80— • 100— Profit or Loss | | | | | | | | | | 5 10 15 20 25 30 35 40 45 50 Units Sold Loss (0, -$100)

  22. The cost-volume-profit graph depicts the relationship among costs, volume, and profits.

  23. Revenue • $500 -- • -- • -- • -- • -- • 250 -- • 200 -- • 150 -- • -- • 50 -- • 0 -- Profit ($100) Total Cost Variable Expenses ($5 per unit) Loss | | | | | | | | | | | | 5 10 15 20 25 30 35 40 45 50 55 60 Units Sold Cost-Volume-Profit Graph Total Revenue Break-Even Point (20, $200) Fixed Expenses ($100)

  24. Assumptions of C-V-P Analysis 1. The analysis assumes a linear revenue function and a linear cost function. 2. The analysis assumes that price, total fixed costs, and unit variable costs can be accurately identified and remain constant over the relevant range. 3. The analysis assumes that what is produced is sold. 4. For multiple-product analysis, the sales mix is assumed to be known. 5. The selling price and costs are assumed to be known with certainty.

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