Chapter 5 - Cost Volume Profit

Cost-Volume-Profit Analysis

1. CM=Sales-Variable Cost 2. CM goes to cover fixed costs 3. After FC, all remaining CM goes to Income

Assumptions of CVP Analysis

1. Selling price is constant 2. Costs are linear 3. In multi-product companies, the sales mix is constant 4. In manufacturing companies, inventories do not change (units produced=units sold)

Define Operating Leverage

A measure of how sensitive net operating income is to percentage changes in sales. With high leverage, a small percentage increase in sales can produce a much larger percentage increase in net operating income.

The Margin of Safety Formula

Budget (Actual) Sales-Break-Even Sales (higher the margin the lower the risk)

Degree of Operating Leverage

CM/Net Income

The Margin of Safety

Excess of budgeted (or actual) sales over the break-even volume of sales. The amount by which sales can drop before losses begin to be incurred.

Contribution Margin for break-even point in total sales dollars

Fixed Costs/CM %

Contribution Margin for Break-even point in units sold

Fixed Costs/Unit CM

The Concept of Sales Mix

Sales mix is the relative proportions in which a company's products are sold. Different products have different selling prices, cost structures, and contribution margins. (do CVP analysis with the cm%)

Break-even point in units

Sales=Variable Expenses+Fixed expenses+Profits EX. 500x=300x+80,000+0 200x=80,000 x=400 bikes

Break-Even point in sales dollars

Sales=Variable Expenses+Fixed expenses+Profits EX. x=.60x+80,000+0 .40x=80,000 x=$200,000

The contribution margin ratio is:

Total CM/Total Sales

In terms of units, the contribution ratio is:

Unit CM/Unit Selling Price

The Contribution Margin Approach

Unit sales to attain the target profit = (Fixed Expenses+Target Profit)/Unit contribution margin

CVP Formula

We can use our CVP formula to determine the sales volume needed to achieve a target net profit figure. Sales=Variable Expenses+Fixed Expenses+Profits