Accounting for Managers Module 8: Cost Volume Profit Analysis
Cost-Volume-Profit Analysis The cost-volume profit (CVP) analysis helps you to better understand the relationships between costs, volumes, and profits by focusing on how pricing products, activity volume, fixed and variable costs interact. Components of the CVP formula: 1. Profit 2. Fixed costs 3. Variable Costs Selling Price - Variable Costs - Fixed Costs = Profit
Contribution Margin Model Contribution margin is defined as the sales less the variable expenses. Sales - Variable Expenses = Contribution Margin
Net Operating Income The profit equation: Profit = Sales - Variable Expenses - Fixed Expenses Example: Monte Corporation sells their widgets for $10 each. The variable cost per widget is $4. Fixed expenses for the company are $400 per month. What would be Monte Corporation profit if they sold 200 units?
Contribution Margin Ratio • The contribution margin ratio is the difference between a company’s sales and variable costs, expressed as a percentage. • This ratio shows the amount of money available to cover fixed costs. (Sales - Variable Expenses)/Sales
Cost-Volume-Profit Analysis and Decision Making • Even a slight change in costs can have a significant effect on the profitability of a company • As a manager, you may be responsible for making sure that costs are kept under control, or sales numbers are kept at a certain level to keep your company profitable
Statement of Fixed Cost and Sales Volume How can you adjust when your fixed costs increase? • Raise the price of the product to compensate for increased expenses • Source less expensivecomponents of your product to lower variable costs • Move to a less expensive facility • Work on increasing the sales of the product
Statement of Variable Costs and Sales Volume What happens when your vendor increases the price of your supplies? Brainstorm some ways to compensate for the change in cost.
Statement of Fixed Cost, Selling Price, and Sales Volume Scenario: You sell widgets. Your competitor just released a new line of widgets for 20% less than your widget AND in several more colors. • What problems could this cause? • How would you compensate for this unseen setback? • How would you create a statement to show your subsequent change in fixed cost, selling price, and sales volume?
Statement of Variable Cost, Fixed Cost, and Sales Volume Scenario: • A lower selling price at $8 per widget • Higher fixed costs at $440 per month • Higher variable costs at $5.50 per widget What would this look like on a new variable cost, fixed cost, and sales volume statement?
Break-Even Point • The break even point can be defined as the exact point where sales - expenses = zero. • Two methods for discovering the break even point: • Equation method • Formula method
Methods to Determine the Break-Even Point Break even point
Target Profit Analysis • Target profit analysis helps us to know how much in dollar sales a company will need to reach a certain profit point • Example: Minnesota Kayak Company needs to sell 28 kayaks to break even. • Target Profit: $30,000 • $500 per kayak • Variable costs per kayak: $225 • Contribution margin per kayak: $275 • Fixed costs/month: $7,700 • How many kayaks need to be sold to break even?
Margin of Safety • The margin of safety is the difference between actual sales and the break even point. • A higher margin of safety is good! Margin of safety = actual (or budgeted) sales - sales required to break even
The Break-Even Point and the Sales Mix What happens if your company sells more than one product? How do you find your break even point and adjust the sales mix accordingly? As a manager, you may be asked to determine a product mix that is profitable for your company.
Cost Structures • The percentage of sales that is related to fixed costs or variable costs is a component of cost structure. • Cost structure refers to the proportion of fixed and variable costs within an organization.
Operating Leverage Degree of operating leverage = contribution margin/net operating income % change in operating income = degree of operating income x % change in sales
Quick Review • Components of CVP • Profit • Fixed Costs • Variable Costs • How can CVP impact your decision making as a manager? • What is the break even point? Why is it important?