Chap 5 Cost-Volume-Profit Relationships

degree of operating leverage

a measure, a given level of sales, of how a percentage change in sales will affect profits.the degree of operating leverage is computed by dividing contribution margin by net operating income. contribution margin/ net operating income

dollar sales to attain the target profit

(target profit +fixed expenses)/CM ratio

Contribution margin

the amount remaining from sales revenue after variable expenses have been deducted.

margin of safety

the excess of the budgeted (or actual)sales dollars over break-even sales dollars.

break-even point

the level of sales at which profit is zero. Once the break-even point has been reached, net operating income will increase by the amount of the unit contribution margin for each additional unit sold.

Cost structure

the relative proportion of fixed and variable costs in an organization.

sales mix

the relative proportions in which a company's products are sold. Sales mix is computed by expressing the sales of each product as a percentage of total sales.

variable expense ratio

variable expenses/sales

relationship between change in sales and cost structure

with its higher fixed costs and lower variable costs, will experience wider swings in net operating income as sales fluctuate, with greater profits in good years and greater losses in bad years. with its lower fixed costs and higher variable costs, will enjoy greater profit stability and will be more protected from losses during bad years, but at the cost of lower net operating income in good years.

dollar sales to break even

Fixed expenses/ CM ratio

assumptions with respect to these factors

1.Selling price is constant. The price of a product or service will not change as volume changes. 2.Costs are linear and can be accurately divided into variable and fixed components. The variable costs are constant per unit and the fixed costs are constant in total over the entire relevant range. 3.In multiproduct companies, the mix of products sold remains constant.

profit

= CM ratio * Sales - Fixed expenses

change in contribution margin

= CM ratio * change in sales

change in profit

= CM ratio * change in sales - change in fixed expenses

margin of safety percentage

= margin of safety in dollars/ total budgeted(or actual)sales in dollars

margin of safety in dollars

= total budgeted(or actual)sales - break-even sales

Cost-volume-profit (CVP) analysis

Its primary purpose is to estimate how profits are affected by the following five factors: 1.Selling prices. 2.Sales volume. 3.Unit variable costs. 4.Total fixed costs. 5.Mix of products sold.

CVP Relationships in Equation

Profit = (Sales - Variable expenses) - Fixed expenses When a company has only a single product, as at Acoustic Concepts, we can further refine the equation as follows: Sales = P*Q Variable expenses = V*Q Profit = (P*Q-V*Q)-Fixed expenses simple profit equation of the unit contribution margin(Unit CM): Profit = UnitCM * Q - Fixed expenses

operating leverage

a measure of how sensitive net operating income is to a given percentage change in dollar sales.

percentage change in net operating income

degree of operating * percentage change n sales

to solve for net operating income at any sales volume above the break-even point requires knowledge of the

projected unit sales break-even unit sales contribution margin per unit