Part Five. Cost Volume Profit Analysis


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1 Part Five Cost Volume Profit Analysis
2 COST VOLUME PROFIT ANALYSIS Study of the effects of changes of costs and volume on a company s profits A critical factor in management decisions Important in profit planning
3 COST VOLUME PROFIT ANALYSIS Considers the interrelationships among the five components of CVP analysis:
4 ASSUMPTIONS UNDERLYING CVP ANALYSIS(Assumptions) Behavior of both costs and revenues is linear throughout the relevant range of the activity index All costs can be classified as either variable or fixed with reasonable accuracy Changes in activity are the only factors that affect costs All units produced are sold When more than one type of product is sold, the sales mix will remain constant
5 CVP INCOME STATEMENT A statement for internal use Classifies costs and expenses as fixed or variable Reports contribution margin in the body of the statement. Contribution margin amount of revenue remaining after deducting variable costs Reports the same net income as a traditional income statement
6 CVP INCOME STATEMENT Contribution Margin Per Unit Contribution margin is available to cover fixed costs and to contribute to income Formula for contribution margin per unit: Unit Selling Price Unit Variable Costs = Contribution Margin per Unit Example: Computation for Vargo Video Unit Selling Price $500 Unit Variable Costs $300 = Contribution Margin per Unit $200
7 CVP INCOME STATEMENT Contribution Margin Ratio Shows the percentage of each sales dollar available to apply toward fixed costs and profits Contribution Margin per Unit Unit Selling Price = Contribution Margin Ratio Example: Computation for Vargo Video Contribution Margin per Unit S200 Unit Selling Price = $500 Contribution Margin Ratio 40%
8 BREAK EVEN ANALYSIS Process of finding the break even point Break even point Level of activity at which total revenues equal total costs (both fixed and variable) Can be computed or derived from a mathematical equation by using contribution margin from a cost volume profit (CVP) graph Expressed either in sales units or in sales dollars
9 BREAK EVEN ANALYSIS Mathematical Equation Example using the Vargo Video data: Sales Variable Costs $300 Q Fixed Costs $500 Q = + + $200,000 Net Income $0 = $200 Q $200,000 Q = 1000 units Where: Q = sales volume; $500 = selling price; $300 = variable cost per unit; $200,000 total fixed costs To find sales dollars required to break even: 1000 units X $500 = $500,000 (break even sales dollars)
10 Breakeven point Volume of sales needed to earn no profit or no loss Revenues = total costs Fixed cost + target profit Contribution margin per unit = number of units Fixed cost + target profit Contribution margin percentage = dollars of sales
11 The breakeven formulas allow us to play what if games What happens if Sales price is increased (or decreased) Variable costs are replaced by fixed costs Volume increases Additional amounts spent on advertising will increase sales volume Etc.
12 Margin of safety The excess of current sales volume over the breakeven point In units Current unit sales breakeven unit sales In percentage (Current sales breakeven sales) / current sales The sales figures may be in dollars or units
13 BREAK EVEN ANALYSIS Margin of Safety Difference between actual or expected sales and sales at the break even point May be expressed in dollars or as a ratio Example To determine the margin of safety in dollars for Vargo Video assuming that actual (expected) sales are $750,000: Actual (Expected) Sales S750,000 Break even Sales = $500,000 Margin of Safety in Dollars $250,000
14 BREAK EVEN ANALYSIS Margin of Safety Ratio Computed by dividing the margin of safety in dollars by the actual or expected sales (using Vargo Video data) Margin of Safety in Dollars $250,000 Actual (Expected) Sales = $750,000 Margin of Safety Ratio 33% Results indicate that Vargo Video s sales could fall by 33 percent before it would be operating at a loss. The higher the dollars or the percentage, the greater the margin of safety.
15 BREAK EVEN ANALYSIS Contribution Margin Technique At the break even point, contribution margin must equal total fixed costs (CM = total revenues variable costs) The break even point can be computed using either contribution margin per unit or contribution margin ratio When the break even point in units is desired, contribution margin per unit is used in the following formula Fixed Costs Contribution Margin per Unit = Break even Point in Units When the break even point in dollars is desired, contribution margin ratio is used in the following formula Fixed Costs Contribution Margin Ratio = Break even Point in Dollars
16 BREAK EVEN ANALYSIS Contribution Margin Technique Example using Vargo Video data: Fixed Costs $200,000 Contribution Margin per Unit = $200 Break even Point in Units 1,000 units Fixed Costs $200,000 Contribution Margin per Unit = 40% Break even Point in Dollars $500,000
17 BREAK EVEN ANALYSIS Graphic Presentation A cost volume profit (CVP) graph shows costs, volume, and profits Used to visually find the break even point To construct a CVP graph, Plot the total revenue line starting at the zero activity level Plot the total fixed cost by a horizontal line Plot the total cost line. (Starts at the fixed cost line at zero activity) Determine the break even point from the intersection of the total cost line and the total revenue line
18 BREAK EVEN ANALYSIS CVP Graph for Vargo Video
19 Cost Volume Profit Graph Sales in Dollars 450, , , , , , , ,000 50,000 Break even even point Total expenses Loss area Total sales Profit area Fixed expenses Units Sold
20 Profit Volume Graph $100,000 Some managers like the profit volume graph because it focuses on profits and volume. $80,000 Profit $60,000 $40,000 $20,000 $ $ $50 $100 $150 $200 $250 $300 $350 $400 $(20,000) $(40,000) $(60,000) $(80,000) Loss area Profit area Break even point $(100,000) Units sold (00s)
21 BREAK EVEN ANALYSIS Target Net Income Level of sales necessary to achieve a specified income Can be determined from each of the approaches used to determine break even sales/units May be expressed either in sales dollars or sales units
22 Sensitivity analysis Change in Sales Price Change in Variable Costs Change in Fixed Costs Change in Volume
23 Operating leverage Measures the relative mix of fixed and variable costs Contribution margin / operating income Can determine the change in operating income that will result from a change in sales by multiplying the % change in sales by the operating leverage High operating leverage implies high risk, high reward
24 Breakeven calculations in a multi product environment Assume the mix of products sold remains constant Determine the contribution margin for a basket of goods (the normal sales mix) Calculate the breakeven point as the number of baskets needed to break even
25 Breakeven calculations in a multi product environment Normal Contribution Total Product sales mix per unit contribution Laptops 6 $ 70 $ 420 Printers Scanners 1 20 $ If fixed costs are $800,000, the breakeven point is $800,000 / 500 = 1,600 "baskets" 9,600 laptops 3,200 printers 1,600 scanners
26 Computing Multiproduct Break Even Point Unit contribution margin is replaced with contribution margin for a composite unit. A composite unit is composed of specific numbers of each product in proportion to the product sales mix. Sales mix is the ratio of the volumes of the various products.
27 Computing Multiproduct Break Even Point The resulting break even formula for composite unit sales is: Break even point in composite units = Fixed costs Contribution margin per composite unit
28 Computing Multiproduct Break Even Point A company sells windows and doors. They sell 4 windows for every door. Windows Doors Selling Price $200 $500 Variable Cost Unit Contribution $ 75 $ 150 Sales Mix Ratio 4 1
29 Computing Multiproduct Break Even Point Step 1: Compute contribution margin per composite unit. Windows Doors Selling Price $200 $500 Variable Cost Unit Contribution $ 75 $ 150 Sales Mix Ratio Composite C/M
30 Computing Multiproduct Break Even Point Step 2: Compute break even point in composite units. Break even point in composite units = Fixed costs Contribution margin per composite unit
31 Computing Multiproduct Break Even Point Step 2: Compute break even point in composite units. Break even point in composite units Break even point in composite units = = Fixed costs Contribution margin per composite unit $900,000 $450 per composite unit Break even point in composite units = 2,000 composite units
32 Computing Multiproduct Break Even Point Step 3: Determine the number of windows and doors that must be sold to break even. Sales Composite Product Mix Units Units Window 4 2,000 = 8,000 Door 1 2,000 = 2,000
33 Multiproduct Break Even Income Statement Step 4: Verify the results. Windows Doors Combined Selling Price $200 $500 Variable Cost Unit Contribution $ $ Sales Volume 8,000 2,000 Total Contribution $ 600,000 $ 300,000 $ 900,000 Fixed Costs 900,000 Income $ 0
34 Thanks for Your Attention
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