MANAGEMENT ACCOUNTING Cost-Volume-Profit Analysis

MANAGEMENT ACCOUNTING Cost-Volume-Profit Analysis Zofia Krokosz-Krynke, Ph.D., MBA zofia.krokosz-krynke@pwr.edu.pl Wroclaw University of Technology, Building B4 Room 521 http://www.ioz.pwr.edu.pl/pracownicy/krokosz/

QUESTIONS ANSWERED BY CVP ANALYSIS 1. What sales volume is required to break even 2. What sales volume is necessary in order to earn a desired profit 3. What profit can be expected on a given sales volume 4. How would changes in selling price, variable costs, fixed costs, and output affect profits 5. How would a change in the mix of products sold affect the break-even and target income volume and profit potencial 2

What sales volume is required to break even break-even point the level of sales at which revenue equals expenses and net income is zero margin of safety the planned unit sales less the break-even unit sales contribution margin (marginal income) the sales price minus the variable cost per unit sales totalcost S = X*P TC = FC + UVC*X break-evenpoint BEP = X; S = TC X*P= FC +UVC*X BEP FC = X = BEPV = BEP* P P UVC quantity unit Contribution Margin(CMU) $ value 3

What sales volume is required to break even cont. cost-volume-profit graph $ break-even point sales (revenue) net income area net income variable expenses net loss area total cost fixed expenses units 4

What sales volume is required to break even cont. conventional and modified break-even graphs relevant range of volume sales relevant range of volume sales total expenses total expenses euros euros activity (volume) level activity (volume) level 5

What sales volume is required to break even cont. Assumptions that must be made in constructing the break-even graph: 1. Expenses may be classified intovariable and fixed categories. Total variable expenses vary directly with activity level. Total fixed expenses do not change with activity level. 2. The behavior of revenues and expenses is accuratly portrayed and islinear over the relevant range. 3. Efficiency and productivity will be unchanged. 4. Sales mix (relative proportions or combinations of quantities of products that constitute total sales) will be constant. 5. The difference in inventory level at the beginning and at the end of a period is insignificant. 6. The price will be unchanged. 7. Sales and expenses are not the subject of time value of money 6

What sales volume is required to break even cont. cost-volume-profit graph two products $ revenue plane expenses plane 20 break-even line break-even q 1 q 1 15 10 net income area q 2 5 net loss area 0 0 1 2 3 4 5 6 7 8 9 10 q 2 7

What sales volume is required to cover cash expenses Euro 700 600 500 400 300 FC VC Sales total expenses cash expenses 200 100 BEP 0 BEPcash activity level FC D BEPcash= P UVC Depreciation 8

What sales volume is necessary in order to earn a desired profit 700 600 500 sales NP net profit tax tax rate (CIT) BEPprofit= FC+ NP/(1 tax) P UVC 400 Euro 300 200 100 0 total costs net income or BEPprofit= BEP+ NP/(1 tax) P UVC -100 net profit or -200 activity level BEPprofit= BEP+ NP CMU* (1 tax) 9

What profit can be expected on a given sales volume Sales P*units sold Expenses: variable (CGS) VC* units sold fixed FC Income Profit P* units sold VC* units sold FC = (P VC) *units sold FC = CMU * units sold FC Income Tax = (CMU * units sold FC) *(1 tax rate) 10

How would changes in selling price, variable costs, fixed costs, and output affect profits alternative cost structure We are going to sell on a fair a software packet Do-All. Software we can buy from the wholesaler for $120 per unit, unsold packet we can return to the wholesaler. The price of $200 per unit seems to be acceptable. Exibition Center (fair s organizer) offers a place we can sell our software according to the following options: a) $2000 b) $1400 plus 5% of sales c) 20% of sales Which option should we choose? option a) option b) option c) 7000 7000 7000 6000 6000 6000 5000 5000 5000 4000 3000 2000 1000 0 0 5 10 15 20 25 30 4000 3000 2000 1000 0 0 5 10 15 20 25 30 4000 3000 2000 1000 0 0 5 10 15 20 25 30 11

How would changes in selling price, variable costs, fixed costs, and output affect profits cont. alternative cost structure option a) BEP= 2000/(200-120) = 25 units option b) BEP= 1400/(200-120-200*0.05) = 20 units option c) BEP= 0/(200-120-200*0.2) = 0 units 7000 6000 5000 4000 option a) option b) option c) net income Dollars 3000 2000 1000 BEP BEP 0-1000 -2000 BEP activity level [units] -3000 option c) option b) option a) 12

How would a change in the mix of products sold affect the breakeven and target income volume and profit potencial S = TC = q i P i qipi = BEPVm qivcui = + q i VCU i FC FC + FC ( P ) i VCUi q i Piqi q i quantity of product i 13

How would a change in the mix of products sold affect the break-even and target income volume and profit potencial cont. product i 1 2 3 price P $10 $20 $5 variable cost per unit VC $3 $15 $2 quantity q 30 units 50 units 20 units fixed cost FC $10 000 10000 BEPV= (10 3)*30+ (20 15)*50+ (5 3)*20 10*30+ 20*50+ 5*20 product i 1 2 3 price P $10 $20 $5 variable cost per unit VC $3 $15 $2 quantity q 50 units 20 units 30 units fixed cost FC $10 000 10000 BEPV = = (10 3)*50+ (20 15)*20+ (5 3)*30 10*50+ 20*20+ 5*30 10000 = = $27000 0,37 10000 0,52 = $19230 14

How would a change in the mix of products sold affect the breakeven and target income volume and profit potencial cont. Case study Valtek Company sells three products. The company pays attention to the budgeting and planning process. The sales budget has been worked out. Product A B C Total % sales 20% 52% 28% 100% Sales 150 000 100% 390 000 100% 210 000 100% 750 000 100% variable costs 108 000 72 % 78 000 20 % 84 000 40 % 270 000 36 % contribution margin 42 000 28% 312 000 80% 126 000 60% 480 000 64% fixed costs 449 280 Profit 30 720 BEPV = 449 280 / 0,64 = $702 000 15

How would a change in the mix of products sold affect the breakeven and target income volume and profit potencial cont. Assume that according to the plan the sales of $750 000 has been reached, and the sales on products was as follows: A - $300 000; B - $180 000; C - $270 000. 1. Prepare the income statement for the month. 2. What is the dollars break-even point for the month? 3. The president is shocked with the results of this month the company s sale (in dollars) is exactly the same as planned. Explain the president why the result and the break even differ from planned. Product A B C Total % sales 100% Sales 300 000 100% 180 000 100% 270 000 100% 750 000 100% variable costs 72 % 20 % 40 % contribution margin 28% 80% 60% fixed costs Profit 449 280 16

How would a change in the mix of products sold affect the breakeven and target income volume and profit potencial cont. Product A B C Total % sales 40% 24% 36% 100% Sales 300 000 100% 180 000 100% 270 000 100% 750 000 100% variable costs contribution margin fixed costs Profit 72 % 20 % 40 % 28% 80% 60% 449 280 17

How would a change in the mix of products sold affect the breakeven and target income volume and profit potencial cont. Product A B C Total % sales 40% 24% 36% 100% Sales 300 000 100% 180 000 100% 270 000 100% 750 000 100% variable costs 216 000 72 % 36 000 20 % 108 000 40 % 360 000 48% contribution margin fixed costs Profit 28% 80% 60% 449 280 18

How would a change in the mix of products sold affect the breakeven and target income volume and profit potencial cont. Product A B C Total % sales 40% 24% 36% 100% Sales 300 000 100% 180 000 100% 270 000 100% 750 000 100% variable costs contribution margin fixed costs Profit 216 000 72 % 36 000 20 % 108 000 40 % 360 000 48% 84 000 28% 144 000 80% 162 000 60% 390 000 52% 449 280 19

How would a change in the mix of products sold affect the breakeven and target income volume and profit potencial cont. Product A B C Total % sales 40% 24% 36% 100% Sales 300 000 100% 180 000 100% 270 000 100% 750 000 100% variable costs contribution margin fixed costs Profit 216 000 72 % 36 000 20 % 108 000 40 % 360 000 48% 84 000 28% 144 000 80% 162 000 60% 390 000 52% 449 280 (59 280) BEPV = 449 280 / 0,52 = $864 000 20

How would a change in the mix of products sold affect the breakeven and target income volume and profit potencial cont. Product A B C Total % sales 40% 20% 24% 52% 36% 28% 100% Sales 300 000 150 000 180 000 390 000 270 000 210 000 750 000 750 000 variable costs 216 000 108 000 36 000 78 000 108 000 84 000 360 000 270 000 contribution margin fixed costs Profit 84 000 42 000 144 000 312 000 162 000 126 00 390 000 480 000 449 280 449 280 (59 280) 30 720 21

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