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Cash, Short-term Investments and Accounts Receivable

Cash, Short-term Investments and Accounts Receivable. Chapter 4. Chapter 12. Cost-Volume-Profit Analysis. Chapter 12 Learning Objectives. Define break-even point (BEP) and cost-volume-profit (CVP) analysis, and recognize their limiting underlying assumptions.

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Cash, Short-term Investments and Accounts Receivable

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  1. Cash, Short-term Investmentsand Accounts Receivable Chapter 4 Chapter 4

  2. Chapter 12 Cost-Volume-Profit Analysis

  3. Chapter 12Learning Objectives • Define break-even point (BEP) and cost-volume-profit (CVP) analysis, and recognize their limiting underlying assumptions. • Use BEP and CVP analysis in both single-product and multiproduct companies. • Develop a break-even chart and profit-volume graph. • Calculate the margin of safety and operating leverage and use those concepts in analysis. Chapter 12

  4. CVP Assumptions • Operating within Relevant Range • All costs are Fixed or Variable • All Revenue and Variable costs are constant per unit • Constant contribution margin (Unit Sales price- Unit Variable cost) • Total fixed cost is constant. Total Revenue Total Cost Sales price * units = Fixed Cost + variable cost * units Solving for “units”: Break even units = Fixed cost Sales – Variable cost/unit Chapter 12

  5. Income Statement Information for Beattie Company Chapter 12

  6. How many units do we need to sell to break even? Total Revenues - Total Costs = Profit R(X) - [VC(X) + FC] = P R(X) - VC(X) - FC = P where R = revenue (selling price) per unit $50 X = number of units sold (volume) R(X) = total revenues VC = variable cost per unit $15 VC(X) = total variable costs FC = total fixed costs $647,500 P = pre-tax profit$0 Using CVP formula: 18,500 units = $647,500/$35 Setting profit equal to $0: or (1) $50X - ($9X + $6X) - $647,500 = $0 (2) $50X - $15X - $647,500 = $0 (3) $35X = $647,500 (4) X = $647,500÷$35 (5) X = 18,500 units Chapter 12

  7. Review Best Company sells a product for $20, variable costs are $5 per unit. Fixed costs are $45,000 annually. How many units does Best have to sell annually to breakeven? • 2,250 • 3,000 • 9,000 • 4,500 Chapter 12

  8. Review Best Company sells a product for $20, variable costs are $5 per unit. Fixed costs are $45,000 annually. How many units does Best have to sell annually to breakeven? • 2,250 • 3,000 • 9,000 • 4,500 Chapter 12

  9. Desired Before-Tax Profit Assume Beattie Company wants to generate a pretax profit of $472,500. To calculate sales necessary to earn a profit, treat the profit as an additional fixed cost. X units = $647,500 + $472,500 $35 X= 32,000 units Chapter 12

  10. Review Best Company sells a product for $20, variable costs are $5 per unit. Fixed costs are $45,000 annually. Best Company desires a before-tax profit of $15,000. How many units does Best have to sell annually to breakeven? • 12,000 • 3,000 • 4,000 • 9,000 Chapter 12

  11. Review Best Company sells a product for $20, variable costs are $5 per unit. Fixed costs are $45,000 annually. Best Company desires a before-tax profit of $15,000. How many units does Best have to sell annually to breakeven? • 12,000 • 3,000 • 4,000 • 9,000 Chapter 12

  12. Desired After-Tax Profit Assume Beattie Company’s tax rate is 35% and managers want to earn $325,000 in after-tax profits. Calculate the pretax earnings necessary to generate after tax earnings: Pre tax earnings =After tax earnings 1 – Tax rate $500,000=$325,000 1-.35 On the next slide, we’ll calculate the number of units we need to sell to meet the managers’ goal. Chapter 12

  13. Desired After-Tax Profit Assume Beattie Company’s tax rate is 35% and managers want to earn $325,000 in after-tax profits. Calculate the pretax earnings necessary to generate after tax earnings: X units = $647,500 + $500,000 $35 X= 32,786 units Chapter 12

  14. Proof of Beattie Company’s Net Income Profitability Chapter 12

  15. Review Best Company sells a product for $20, variable costs are $5 per unit. Fixed costs are $45,000 annually. Best Company desires an after-tax profit of $15,000. Best is in a 40% tax bracket. How many units does Best have to sell annually to breakeven? • 4,667 • 5,333 • 5,500 • 14,000 Chapter 12

  16. Review Best Company sells a product for $20, variable costs are $5 per unit. Fixed costs are $45,000 annually. Best Company desires an after-tax profit of $15,000. Best is in a 40% tax bracket. How many units does Best have to sell annually to breakeven? • 4,667 • 5,333 • 5,500 • 14,000 Chapter 12

  17. Summary of BEP and CVP Relationships Chapter 12

  18. Using Incremental Analysis – Increase in Fixed Cost Chapter 12

  19. Using Incremental Analysis – Decrease in Selling Price Chapter 12

  20. Using Incremental Analysis – Increase in Sales Volume and Costs (1) Chapter 12

  21. Using Incremental Analysis – Increase in Sales Volume and Costs (2) Chapter 12

  22. Review Best Company sells a product for $20, variable costs are $5 per unit. Fixed costs are $45,000 annually. Ignoring taxes, what is the breakeven point in units if Best is able to reduce fixed costs by $5,000. • 4,667 • 5,333 • 8,000 • 2,667 Chapter 12

  23. Review Best Company sells a product for $20, variable costs are $5 per unit. Fixed costs are $45,000 annually. Ignoring taxes, what is the breakeven point in units if Best is able to reduce fixed costs by $5,000. • 4,667 • 5,333 • 8,000 • 2,667 Chapter 12

  24. Review Best Company sells a product for $20, variable costs are $5 per unit. Fixed costs are $45,000 annually. Ignoring taxes, what is the breakeven point in units if Best increases the selling price by $2 per unit. • 3,462 • 2,647 • 9,000 • 2,667 Chapter 12

  25. Review Best Company sells a product for $20, variable costs are $5 per unit. Fixed costs are $45,000 annually. Ignoring taxes, what is the breakeven point in units if Best increases the selling price by $2 per unit. • 3,462 • 2,647 • 9,000 • 2,667 Chapter 12

  26. Multi Product Analysis • Assume constant product mix • Calculate contribution margin per basket • Calculate break-even baskets • Determine total units per product Chapter 12

  27. Multiple Product Cost Information for Beattie Company Chapter 12

  28. Change in Sales Mix for Beattie Company Chapter 12

  29. Graphic Approaches to BEP and CVP Problems • Solving break-even and CVP problems using the algebraic or income statement approach provides a specific numerical answer. • However, solutions may also be presented in a pictorial, or graphic form. • Two depictions, the break-even graph and the profit-volume graph are presented next. Chapter 12

  30. Break-Even Graph for Beattie Company Chapter 12

  31. Profit-Volume Graph for Beattie Company Chapter 12

  32. Additional Concepts Margin of Safety Operating Leverage Chapter 12

  33. Margin of Safety • Margin of safety represents the excess of sales over the break-even point. • Margin of safety represents the level by which sales can fall before the BEP is reached. • The margin of safety may be calculated in units or dollars. Chapter 12

  34. Margin of Safety • Recall that Beattie Company’s break-even point is 18,500 units, or $925,000 of sales. • Beattie Company is current selling 25,000 units, providing $1,250,000 of total revenue. • Beattie Company’s margin of safety is calculated as follows: Chapter 12

  35. Degree of Operating Leverage • The degree of operating leverage (DOL) is closely related to the margin of safety. • The DOL reflects an organization’s variable and fixed cost relationship and measures how a percentage change in sales from the current level will affect profits. • The formula for DOL is shown below: Chapter 12

  36. DOL for Beattie Company • Assume Beattie Company is current selling 19,000 units. • On the next slide, we can see what happens to pretax profit as the sales volume changes. • When a company experiences a specified increase or decrease in sales volume, the profit change equals the DOL times the percentage change in sales. Chapter 12

  37. DOL for Beattie Company Chapter 12

  38. Problem Review Line Company reports the following income statement for the year ended December 31, 2010: • Compute the degree of operating leverage for Line Company. • Compute the new net income if sales increase by 20%. • Compute the new net income if sales decrease by 10%. Chapter 12

  39. Problem Review Solution • DOL = $120,000/$40,000 = 3 • 3 X 20% = 60% increase in pretax profit. • $40,000 X 1.6 = $64,000 new pretax profit • c. 3 X 10% = 30% decrease in pretax profit • $40,000 X .7 = $28,000 new pretax profit Chapter 12

  40. Conclusions • At break even, total cost = total revenue • There are strict assumptions in CVP analysis • CM ratio is CM per unit/SP per unit. • Desired profit must be adjusted for taxes. • Multi-product CVP analysis can be accomplished. • Operating leverage can be used in sensitivity analysis Chapter 12

  41. THE END! Chapter 12

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