6 Slide 1 Cost-Volume-Profit Analysis Chapter 6 Main Concepts: 1. Basics of CVP Analysis 2....

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Slide 1

Cost-Volume-Profit Cost-Volume-Profit AnalysisAnalysis

Chapter

6

Chapter

6Main Concepts:

1. Basics of CVP Analysis

2. Contribution Approach 3. Break-Even Analysis a. Equation Method b. Contribution Margin Method

4. The Concept of Sales Mix

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Assumptions of CVP AnalysisAssumptions of CVP Analysis

Selling price is constant throughout the entire relevant range.

Costs are linear throughout the entire relevant range.

In multi-product companies, the sales mix is constant.

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Slide 3

The Basics of Cost-Volume-Profit (CVP) AnalysisThe Basics of Cost-Volume-Profit (CVP) Analysis

Contribution Margin (CM) is the amount

remaining from sales revenue after variable cost have been deducted.

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CM goes to cover fixed costs.

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After covering fixed costs, anyremaining CM contributes to income.

Sales (500 bikes) 250,000$Less: variable expenses 150,000 Contribution margin 100,000 Less: fixed expenses 80,000 Net income 20,000$

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The Contribution ApproachThe Contribution Approach

Consider the following information developed by the accountant at Sakuraba Co.:

Total Per Unit PercentSales (500 bikes) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%

Less: fixed expenses 80,000 Net income 20,000$

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For each additional unit Sakuraba sells, $200 more in contribution margin will help to cover

fixed costs and profit.



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Each month Sakuraba must generate at least $80,000 in CM to break even for the month.



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If Sakuraba sells 400 units 400 units in a month, it will be operating at the break-even pointbreak-even point.


Less: fixed expenses 80,000 Net income -$

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If Sakuraba sells one additional unit (401 bikes), net income will increase by $200.


Less: fixed expenses 80,000 Net income 200$

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The Contribution ApproachThe Contribution ApproachThe break-even point can be defined either

as:The point where total sales revenue equals total

costs (variable and fixed).The point where total contribution margin equals

total fixed costs.

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Contribution Margin RatioContribution Margin Ratio

The contribution margin ratio ratio is defined as follows:

Contribution margin Contribution margin SalesSales = CM Ratio= CM Ratio

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Contribution Margin RatioContribution Margin RatioThe contribution margin ratio ratio is defined as follows:

For Sakuraba, the contribution margin ratio is:

Contribution margin Contribution margin SalesSales = CM Ratio= CM Ratio

$200 $200 $500$500 = 40%= 40%

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At Sakuraba, each $1.00 increase in sales revenue results in a total contribution margin

increase of 40¢.

If sales increase by $50,000, what will be the If sales increase by $50,000, what will be the increase in total contribution margin? increase in total contribution margin?

$20,000 = $.40 x $50,000

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400 Bikes 500 BikesSales 200,000$ 250,000$Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net income -$ 20,000$

A $50,000 increase insales revenue

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400 Bikes 500 BikesSales 200,000$ 250,000$Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net income -$ 20,000$

A $50,000 increase in sales revenueresults in a $20,000 increase in CM.

($50,000 × 40% = $20,000)

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Break-Even AnalysisBreak-Even AnalysisThe break-even point is the point where

Total sales revenue = total costs ororTotal contribution margin = total fixed costs.

Break-even analysis can be approached in two ways:Equation methodContribution margin method.

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Equation MethodEquation Method

Sales – (Variable costs + Fixed costs) = ProfitsSales – (Variable costs + Fixed costs) = Profits

Sales = Variable costs + Fixed costs + ProfitsSales = Variable costs + Fixed costs + Profits

At the break-even point At the break-even point profits equal zero.profits equal zero.

OR

S/uX = VC/uX + Fixed costs + ProfitsS/uX = VC/uX + Fixed costs + Profits

OR

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Equation MethodEquation Method

Here is the information from the Sakuraba Co.:



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Equation MethodEquation Method We calculate the break-even point as follows:


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$500X = $300X + $80,000 + 0$500X = $300X + $80,000 + 0

Where:Where:X X = Number of bikes sold= Number of bikes sold$500 $500 = Unit sales price= Unit sales price$300 $300 = Unit variable cost= Unit variable cost$80,000 $80,000 = Total fixed costs= Total fixed costs

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$500X = $300X + $80,000 + 0$500X = $300X + $80,000 + 0

$200X = $80,000$200X = $80,000

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$500X = $300X + $80,000 + 0$500X = $300X + $80,000 + 0

$200X = $80,000$200X = $80,000

X = 400 unitsX = 400 units

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Contribution Margin MethodContribution Margin Method

The contribution margin method is a variation of the equation method.

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Fixed costs Fixed costs Unit contribution margin Unit contribution margin ==

Break-even pointBreak-even pointin units soldin units sold

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Fixed costs Fixed costs Unit contribution margin Unit contribution margin ==

Break-even pointBreak-even pointin units soldin units sold

$80,000 $80,000 $200$200 = 400 bikes= 400 bikes

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We can calculate the break-even point in total sales dollars as follows:

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Fixed costs Fixed costs CM ratioCM ratio ==

Break-even point inBreak-even point intotal sales dollarstotal sales dollars

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Fixed costs Fixed costs CM ratioCM ratio ==

Break-even point inBreak-even point intotal sales dollarstotal sales dollars

$80,000 $80,000 40%40% = $200,000 sales= $200,000 sales

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CVP Relationships in Graphic FormCVP Relationships in Graphic Form Viewing CVP relationships in a graph gives managers a

perspective that can be obtained in no other way. Consider the following information for Sakuraba Co.:

Income 300 units

Income 400 units

Income 500 units

Sales 150,000$ 200,000$ 250,000$Less: variable expenses 90,000 120,000 150,000 Contribution margin 60,000$ 80,000$ 100,000$Less: fixed expenses 80,000 80,000 80,000 Net income (loss) (20,000)$ -$ 20,000$

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-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

- 100

200

300

400

500

600

700

800

CVP GraphCVP Graph

Fixed costs

Units

Dol

lars

$80,000

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-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

- 100

200

300

400

500

600

700

800

CVP GraphCVP Graph

Units

Dol

lars

Variable costs

$300/unit X$90,000/300 units

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-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

- 100

200

300

400

500

600

700

800

CVP GraphCVP Graph

Total costs

Units

Dol

lars

$80,000 + $300X

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-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

- 100

200

300

400

500

600

700

800

CVP GraphCVP Graph

Total Sales

Units

Dol

lars

$500/unit X$150,000/300 units

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-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

- 100

200

300

400

500

600

700

800

CVP GraphCVP Graph

Break-even point

Units

Dol

lars

Y = a + bX

Price X

a + bX = Price X

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-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

- 100

200

300

400

500

600

700

800

CVP GraphCVP Graph

$80,000 + $300/unit (400 units) = $500/unit (400 units)

= $200,000

Units

Dol

lars

Y = a + bX

Price X

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Slide 37

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

- 100

200

300

400

500

600

700

800

CVP GraphCVP Graph

Break-even point400 units or

$200,000 sales.

Units

Dol

lars

Y = a + bX

Price X

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Let’s Test Your Understanding!Let’s Test Your Understanding!

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Basics of CVP AnalysisBasics of CVP Analysis

1. What does CVP stand for?

2. Compare the Traditional and Contribution Income Statement.

Cost-Volume-Profit

Sales Sales-CGS -VarExp GM CM-S&A -Fixed Exp NI NI

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Break-Even AnalysisBreak-Even Analysis

1. The Contribution Ratio = ________________________________.

2. At Break-Even, fixed costs = ________________________.

3. At Break-Even, sales = ________________________________.

4. Units at Break-Even = ________________________.

5. Sales at Break-Even = ________________________.

Total CM/Sales or CM per unit/Price

Sales - Var Exp. = CM

Total Exp = Fixed Exp. + Var. Exp

Fixed Exp./CM per unit

Fixed Exp./CM%

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Exercise 1Exercise 1Pringle Company manufactures and sells a single product. The

company’s sales and costs for a recent month follow:

Total Per Unit

Sales $600,000 $40

Less variable expenses $420,000 $28

Contribution margin $180,000 $12

Less fixed expenses $150,000

Net income $30,000

1. What is the monthly break-even point in units sold and in sales dollars?2. Without resorting to computations, what is the total contribution margin at the break-even point.3. What is the company’s CM ratio? If monthly sales increase by $80,000 and there is no change in fixed costs, by how much would you expect monthly net income to increase.

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Exercises 1Exercises 11. What is the monthly break-even point in units sold and in sales dollars?

S/uX = VC/uX + Fixed costs + Profits$40X = $28X + $150,000 + $0$12X = $150,000 X = $150,000/$12 X = 12,500 units

12,500 units x $40/u = $500,000

2. Without resorting to computations, what is the total contribution margin at the break-even point.

The fixed cost of $150,000, which would yield a profit of zero.

3a. Determine the CM ratio?

CM ratio = CM/Sales = $180,000/$600,000 = 30%3b. If monthly sales increase by $80,000, by how much would you expect monthly net

income to increase

CM ratio X Sales = 30% X $80,000 = $24,000

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Exercise 2Exercise 2Super Sales Company is the exclusive distribution for a new

product. The product sells for $60 per unit and has a CM ratio of 40%. The company’s fixed costs are $360,000 per year.

1. What are the contribution margin & variable costs per unit?

2. Using the equation method: a. What is the break-even point in units and in sales dollars?

CM per unit = $60 x 40% = $24Variable exp. per unit : $60 x (100% - 40%) = $36

S/uX = VC/uX + Fixed costs + Profits $60X = $36X + $360,000 + $0 X = 15,000 units

orFixed costs/CM per unit = $360,000/$24 per unit = 15,000 units

Sales@BE = PriceX = $60/unit (15,000 units) = $900,000or

Sales@BE = Fixed costs/CM ratio = $360,000/40%= $900,000

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Target Net Profit AnalysisTarget Net Profit Analysis

Suppose Sakuraba Co. wants to know how many bikes must be sold to earn a profit of $100,000.

We can use our CVP formula to determine the sales volume needed to achieve a target net profit figure.

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The CVP EquationThe CVP EquationS/uX = VC/uX + Fixed costs + ProfitsS/uX = VC/uX + Fixed costs + Profits

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$500X = $300X + $80,000 + $100,000

Where:

X = Number of bikes sold$500 = Unit sales price$300 = Unit variable cost$80,000 = Total fixed costs$100,000 = Target net income

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$500X = $300X + $80,000 + $100,000

$200X = $180,000

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$500X = $300X + $80,000 + $100,000

$200X = $180,000

X = 900 bikes

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The Contribution Margin ApproachThe Contribution Margin Approach

We can determine the number of bikes that must be sold to earn a profit of $100,000 using the contribution margin approach.

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Fixed costs + Target profit Unit contribution margin

=Units sold to attain

the target profit

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Fixed costs + Target profit Unit contribution margin

=Units sold to attain

the target profit

$80,000 + $100,000 $200

= 900 bikes

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The Concept of Sales MixThe Concept of Sales Mix

For a company with more than one product, sales mix is the relative combination in which a company’s products are sold.

Different products have different selling prices, cost structures, and contribution margins.

Let’s assume Sakuraba sells bikes and carts and see how we deal with break-even analysis.

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Sakuraba provides us with the following information:

Bikes CartsPrice $15.00 $22.50VC/u $8.00 $9.50CM/u $7.00 $13.00

Expected unit sales 70,000 140,000Sales Mix 1/3 2/3

Fixed Costs $1,320,000.00

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Find breakeven point in total units.

$1,320,000____$1,320,000____ =120,000 units=120,000 units (1/3)$7 + (2/3)$13(1/3)$7 + (2/3)$13




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Separate total units by product mix.

Bikes: 120,000 x 1/3 = 40,000 unitsBikes: 120,000 x 1/3 = 40,000 unitsCarts: 120,000 x 2/3 = Carts: 120,000 x 2/3 = 80,000 units80,000 units

TotalTotal 120,000 units 120,000 units




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The Margin of Safety or Safety MarginThe Margin of Safety or Safety Margin

Excess of budgeted (or actual) sales over the break-even volume of sales

Amount by which sales can drop before losses begin to be incurred

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The Margin of SafetyThe Margin of Safety

Excess of budgeted (or actual) sales over the break-even volume of sales.

Amount by which sales can drop before losses begin to be incurred.

Total sales - Break-even sales = Margin of safety

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Excess of budgeted (or actual) sales over the break-even volume of sales.

Amount by which sales can drop before losses begin to be incurred.

Let’s calculate the margin of safety for Sakuraba.Total sales - Break-even sales = Margin of safety

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Sakuraba has a break-even point of $200,000. If actual sales are $250,000, the margin of

safety is $50,000 or 100 bikes.Break-even

sales 400 units

Actual sales 500 units

Sales 200,000$ 250,000$ Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net income -$ 20,000$

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The margin of safety can be expressed as 20 20 percent percent of sales . . . ($50,000 ÷ $250,000)

Break-even sales

400 unitsActual sales

500 unitsSales 200,000$ 250,000$ Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net income -$ 20,000$

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6 Slide 1 Cost-Volume-Profit Analysis Chapter 6 Main Concepts: 1. Basics of CVP Analysis 2....

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