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Chapter Four

Chapter Four. Cost–Volume–Profit Analysis. CVP Analysis. Estimates how changes in costs, sales, volume, and price affect a company’s profit. Powerful tool for planning and decision making.

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Chapter Four

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  1. Chapter Four Cost–Volume–Profit Analysis

  2. CVP Analysis • Estimates how changes in costs, sales, volume, and price affect a company’s profit. • Powerful tool for planning and decision making. • Most versatile and widely applicable tools used by managerial accountants to help managers make better decisions

  3. Break-Even Point • Point where Total Revenue = Total Costs • Use contribution margin income statement to calculate the Break-even point. • Break-even point can be calculated in number of units and sales dollars. • Once fixed costs have been covered, net income will increase by the per unit contribution margin for each additional unit sold

  4. Contribution Margin • CM = Revenue – Variable Costs • CM represents the amount available to cover fixed expenses and thereafter provides profits. • CM can be calculated in total or per unit. • CMU = Selling Price – Var. Cost per Unit

  5. Contribution Margin Income Statement Sales Revenue (Variable Costs) Contribution Margin (Fixed Costs) Operating Income *When using this format, costs include product as well as period costs.

  6. Whittier Company plans to sell 1,000 mowers at $400 each in the coming year. Product costs include: • Direct materials per mower $180 • Direct labor per mower $100 • Variable factory OH per mower $25 • Total fixed factory OH $15,000 • Variable selling expense is a commission of $20 per mower; fixed selling and admin expenses totals $30,000

  7. Contribution Margin Income Statement Sales ($400 * 1,000) $400,000 Variable cost ($325 * 1,000)(325,000) Contribution margin $ 75,000 Fixed costs( 45,000) Operating income $ 30,000 *CM per unit = $400 – 325 = $75 **VC per unit = $180 + 100 + 25 + 20 ***FC = $15,000 + $30,000 = $45,000

  8. Break-even Point in Units Sales – VC - FC = Operating Income • At break-even point, operating income = $0. • Calculate BE point in units using previous example: Sales – VC – FC = Income $400X - $325X - $45,000 = $0 $400X - $325X = $45,000 $45,000 / $75X X = 600 mowers

  9. Break-even Point in Units • Operating income equation can be rearranged as follows to calculate number of units at breakeven • BE units = Total FC / (SP – VC per unit) • Looking back at previous example • =$45,000 / ($400 - $325)

  10. Break-even Point in Sales Dollars • Unit sold measure is converted into sales dollars # of units sold * sales price per unit = sales revenue • Sales revenue needed in order to breakeven =600 mowers * $400 = $240,000

  11. Variable Cost Ratio &Contribution Margin Ratio • VC Ratio = VC expressed as % of sales dollars • CM Ratio = CM expressed as % of sales dollars • VC Ratio + CM Ratio = 100% • If VC Ratio = 70%, then CM Ratio = ? %

  12. Variable Cost Ratio • Variable Cost Ratio – proportion of each sales dollar that must be used to cover variable costs • Can be calculated using total data or unit data VC Ratio = VC per unit / SP per unit • VC Ratio = $325 / $400 • VC Ratio = 81.25%

  13. Contribution Margin Ratio • Percentage of sales dollars remaining after variable costs are covered • Proportion of each sales dollar available to cover fixed costs and provide for profit CM Ratio = CM per unit / SP per unit • CM Ratio = $75 / $400 • CM Ratio = 18.75%

  14. Break-even Point in Sales Dollars BE Sales = FC / CM Ratio • BE Sales = $45,000 / 18.75% • BE Sales = $240,000

  15. Calculating Sales Needed to Earn a Target Operating Income • Whittier sells mowers at $400 each. Variable cost per unit is $325 and total fixed cost is $45,000. • Calculate sales that Whittier must make to earn an operating income of $37,500 Sales – VC – FC = Operating Income $400X - $325X - $45,000 = $37,500 $75X = $82,500 X = $82,500 / $75 X = 1,100

  16. What happens if a company sells more than one product?

  17. Whittier Company • Decides to offer two models of lawn mowers: mulching mower (SP = $400) & riding lawn mower (SP = $800)

  18. Weighted-AverageContribution Margin per Unit • In the real world, a company sells more than one product. • Have to find weight-average contribution margin: • Several ways to calculate, but one way is--total contribution margin divided by the total units: $250,000/2,000 = $125

  19. Use $125 to find break-even point for company. • $125X – 70,000 – 26,250 = $0 • $125X = $96,250 • X = $96,250/$125 • X = 770 units • How many mulching mowers? • 770 * 60% = 462 • How many riding mowers? • 770 * 40% = 308

  20. Margin of Safety • The units sold or revenue earned above the break-even volume. • “Wiggle room” = Actual or Target Sales – Breakeven Sales

  21. Example Whittier Company • Break-even Point = 600 units or $240,000 sales dollars • Target Point = 1,000 units or $400,000 sales dollars Margin of Safety: • Units = 1,000 – 600 = 400 units • Sales dollars = $400,000 – 240,000 = $160,000

  22. Operating Leverage • Concerned with the relative mix of fixed costs and variable costs in an organization. • As variable costs decrease, the unit CM increases, making the contribution of each unit sold that much greater. • Degree of OL = CM / Operating Income

  23. Operating Leverage • Whittier plans to sell 1,000 mowers at $400 each and has VC per unit of $325 and FC of $45,000. Operating income at that level of sales is $30,000. • OL = $75,000 / $30,000 = 2.5 • Use of OL: Degree of OL * % change in sales = % change in income • If company sales increase 20%, but how much income increase? • 2.5 * 20% = 50%

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