COST-VOLUME-PROFIT RELATIONSHIP

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## COST-VOLUME-PROFIT RELATIONSHIP

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**COST-VOLUME-PROFIT RELATIONSHIP**CHAPTER 5**CVP Formula**• Sx = VCx + FC + P • S= Selling Price • X= Sales Volume • VC = Variable Cost per unit • FC = Fixed Cost • P= Profit • Very powerful equation • If all else fails just work the equation**Things you can find out using CVP formula**• Breakeven points • Units to sell to get a certain profit • How many more to sell if Fixed Cost increased • Selling Price**Apply CVP Formula**• Selling Price $36 • Variable Cost $24 per unit • Fixed Costs $12,000 • Units 2,000 • Profit= ? • Put in CVP formula**CONTRIBUTION MARGIN**• The amount that contributes to fixed costs and profits i.e Contribution • Calculated In per unit, $ and in % • $100 Sales • 60 VC • $ 40 CM 40% Ratio ($40/$100= .40) • 35 FC • $ 5 NI**CONTRIBUTION MARGIN FORMAT Income Statement**• SALES • -VARIABLE COST • =CONTRIBUTION MARGIN • - FIXED EXPENSES • NET OPERATING INCOME • Exercise 5-1 page 213**Application of CVP Data**• Exercise 5-5 page 214 • 1- Increase advertising budget • 2- Increase quality of product**BREAK EVEN (BE) IN UNITS & $**• The units or $ that will cover the fixed costs with no profit. • Sx – VCx= FC BE in equation method • FC/CM% = BE$ CM Method • You can determine: BE in units, BE in $ • Exercise 5-7 pg 214**PROFIT PLANNING**• Answers these questions: • How many do I need to sell to make $100,000 profit • For example: If I reduce my fixed costs by $2,000 and increase my sales in units by 100 how will my profit change?**Target Profit Analysis**• Formula for units to make a $ profit • FC + Profit • Unit CM • X sales price = Sales to attain target profit • Exercise 5-6 pg 214 • 1- equation method • 2- CM approach**Margin of Safety (MS)**• Amount you can drop before losses are incurred • How much can our sales drop before we start losing money • Every company has a different % because each is structured differently • How much excess you have over break even. • How much you have after you cover your fixed costs.**Margin of Safety formula**• Budgeted Sales – BE$ = MS$ • MS$/Budgeted Sales=MS% • Example: • Sales $100,000 • BE$ 87,500 • MS$ $ 12,500 / 100,000 = 12.5% • Exercise 5-8 page 214**Operating Leverage (OL) pg 202**• How sensitive income is to a % change in Sales $ • How a % change in Sales volume will affect profits. • It is a Multiplier • If OL is high a small % change in Sales will reuslt in a higher change in NI**Operating Leverage Formula**• Contribution Margin $ • Net Income in $ • It OL is 2 and sales increased by 5% then net income will increase by 10% • Exercise 5-9 pg 215**Operating leverage proof**• Sales 100,000 110,000 • VC 60,00066,000 • CM 40,000 44,000 • FC 35,000 35,000 • NI 5,000 9,000 $4,000 • OL 40,000/5000= 8 times x 10% • 80% x $5000 = $4000**CM Ratio**• Another way to determine effect on net income • Change in Net Income with the change in Total Sales • If we sell 10,000 more units, how would our net income increase? • 10,000 X25%CM= 2500 change in units X $24 per unit = $60,000 increase in NI • How much would our net income increase if our sales increase by $240,000 • $240,000 X 25% = $60,000**Sales Mix Multi Product CM**• Proportions in which a company’s products are sold • Mix that will yield the greatest profit • Steps to determine • 1- Total all sales • 2- VC % for each product and total sales • 3- = CM% for all sales • 4- Determine total BE$ FC/CM% • 5- Each product % of total sales X BE$ • 6- Use VC% for each product for VC • 7- =CM for each product = total fixed costs • Page 206 Exhibit 5-4 • Exercise 5-10, pg 215