part, except for use as permitted in a license distributed with a certain product or service or
otherwise on a password-protected website for classroom use.
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CHAPTER GOAL
This chapter explains and illustrates financial modeling. Financial modeling canProvide an overview of an organization’s financial
activitiesHelp managers make specific decisions
Financial modeling relies on concepts of fixed and variable cost behavior.
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FINANCIAL MODEL
Financial modeling enables analysts to test the interaction of economic variables in a variety of settings. It requires analysts to develop a set of equations that represents a company’s operating and financial relations.
Financial modeling enables analysts to test the interaction of economic variables in a variety of settings. It requires analysts to develop a set of equations that represents a company’s operating and financial relations.
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COST-VOLUME-PROFIT (CVP)
CVP can be used to answer questions such as What effect on profit can GM expect if it builds a
larger SUV?How will NBC’s profit change if ratings increase
for its evening news program?How many subscribers must a Dish Network
obtain to break even for the year?What happens if Verizon reduces fees charged to
customers?
LO 2
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EXAMPLE: Early Horizons Daycare
Early Horizons Daycare is a daycare center that defines a unit of output as “service provided for 1 child for a month.” Building capacity is 30 children. An accountant developed the following estimates:
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Continued
Price per child per month $ 600
Variable cost per child per month 200
Fixed costs per month 5,000
EHD
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CAPACITY and COSTS Early Horizons Daycare has a capacity of 20
units (relevant range), after which it must hire more staff.Variable costs include
Snacks and food Supplies A portion of insurance
Fixed costs include:Rent and utilitiesA portion of insuranceMinimum staffing
Refers to the proportion of fixed and variable costs to total costs.
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OPERATING LEVERAGE: Definition
OPERATING LEVERAGE: Definition
Is the extent to which an organization’s cost structure is made up of fixed costs.
Note: the higher the fixed costs, the higher the break-even point.
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What is the contribution margin
ratio?
Contribution margin ratio (CMR) is the contribution amount per dollar of sales.
CM / Sales
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LO 6MANAGERS WANT TO KNOW!
How can a company determine the effect of
taxes will be on its profits?
After tax profits = Before tax profits X (1 - tax rate)
EHD
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SUMMARY OF SIMPLIFYING CVP ASSUMPTIONS
Can separate total costs into fixed and variableCost and revenue behavior is linear. Implies
the following in the relevant rangeTotal fixed costs do not change Variable costs per unit remain constantSelling price per unit remains constant
Product mix remains constant over relevant range
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USING ABC FOR EHD
Previously, Early Horizons Daycare used a financial model with only volume (number of children) as the cost driver. What if multiple cost drivers using the cost hierarchy are identified and used?
Previously, Early Horizons Daycare used a financial model with only volume (number of children) as the cost driver. What if multiple cost drivers using the cost hierarchy are identified and used?
LO 8EHD
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Activity Category ExampleCapacity Size limitations Building size: 30 children
