chapter 5
net income =
(Contribution Margin/unit x #units) - fixed costs
Breakeven Sales =
(Fixed Costs) / Overall CM ratio
CM ratio =
total CM / Sales
overall CM ratio
total CM / total sales
The break-even point is the level of sales at which the profit equals
zero
With regards to interpretation, what are the important areas that appear on a CVP graph?
loss area, breakeven point, profit area
margin of safety in percent =
margin of safety in $ / total sales
degree of operating leverage
measures degree to which a company uses fixed resources
Degree of operating leverage
measures the degree to which a company uses fixed resources
if volume increases
net income increases by CM per unit
If volume increases by 1 unit
net income increases by the CM per unit
fixed expenses are not presented as what
on a per unit basis, as it could confuse user
The measure of how sensitive net operating income is to a given percentage change in volume sales is called
operating leverage
contribution margin ratio
percent increase in profit on the bottom line for percent increase in sales
Fixed Expenses are NOT
presented on a per unit basis, as it could mislead users
Once the break-even point has been reached, contribution margin becomes
profit
CM ratio is the % increase in
profit on the bottom line for the % increase in sales
cost structure
relative proportion of fixed and variable costs in an organization
Cost structure
relative proportion of fixed and variable costs in an organization. Managers often have some latitude in determining their organization's cost structure
variable costs for cost per unit
remains constant
loss area
revenue < total cost
loss area =
revenue < total cost
profit area
revenue > total cost
profit area =
revenue > total cost
total contribution margin =
sales - all variable costs
if volume changes what is constant
selling price per unit variable costs per unit total fixed costs
The break-even point calculation is affected by:
selling price per unit. sales mix. costs per unit.
selling price per unit =
target profit / # of units + variable cost per unit
margin of safety
the amount by which sales can drop before losses are incurred
variable cost per unit =
the change in cost / the change in units
CM Ratio can be used to quickly estimate
the impact of a change in sales volume and to derive breakeven point
The higher the margin of safety
the lower the risk of incurring a loss.
breakeven point
the point at which the costs of producing a product equal the revenue made from selling the product
CM per unit =
total CM / # of units
# of units =
total CM / CM per unit
high-low method formula
variable cost = (high cost - low cost) / (high activity - low activity)
variable expense ratio =
variable expense / sales
The contribution margin equals sales minus all
variable expenses
variable total costs increases
with an increase in activity
Profit =
(selling price per unit × quantity sold) - (variable expense per unit × quantity sold) - fixed expenses
unit of sales to target profit =
(target profit + fixed expenses) / CM per unit
CVP analysis five factors
- Selling Prices - Sales Volume - Unit Variable Costs - Total Fixed Costs - Mix of Products Sold
CVP calculation assumptions
- Selling price is constant (will not change as volume changes) - Costs are linear and can be accurately divided into variable and fixed components - In multi-product companies, the mix of products sold remains constant
When making a decision using incremental analysis consider the
- change in sales dollars resulting specifically from the decision - volume that would occur regardless of the decision change in cost resulting specifically from the decision
break-even occurs when
- net income = 0 - sales = all cost amounts - contribution margin = fixed costs
If volume changes,
- selling price per unit - variable costs per unit - total fixed costs are CONSTANT and will NOT change
what CVP analysis do managers calculate to show what profits are affected
- selling prices - sales volume - unit variable costs - total fixed costs - mix of products sold
At the break-even point
- total revenue equals total cost - net operating income is zero
% Change in Net Income =
Degree of Operating x % Change in sales
contribution margin ratio reflects
amount of contribution margin increase
What is usually plotted as a horizontal line on the CVP graph?
fixed expenses
operating leverage shows
how sensitive net operating income is to a given percentage change in sales dollars
high fixed cost structure
income is higher in good years (low variable costs)
HIGH FIXED COST STRUCTURE
income will be higher in good years - low variable cost
LOW FIXED COST STRUCTURE
income will be lower in good years - high variable cost
A shift in the sales mix from low-margin items to high-margin items can cause total profit to
increase
profit =
(CM ratio x sales) - fixed expenses
cvp assumptions
1. Sales price remains constant throughout the relevant range of volume 2. Managers can classify each cost as either variable or fixed 3. Inventory levels will not change 4. The product mix offered for sale remains constant
adding additional expenses to increase sales and change net operating income =
CM per unit x number of units added - additional expense
Degree of Operating Leverage =
Contribution Margin / Net Operating Income
Proper cost driver(s)
Good cause and effect relationship (Economically plausible relationship)
Margin of Safety Percentage
Margin of Safety in $ /Total Sales
breakeven occurs when
Net income = 0 Sales = all costs (variable and fixed) Contribution margin = fixed costs
The profit graph is based on the following linear equation:
Profit = Unit CM × Q - Fixed Expenses.
sales mix
The term used for the relative proportion in which a company's products are sold is
Margin of Safety in dollars
Total Sales - BE Sales
margin of safety in dollars =
Total Sales - Break Even Sales
Overall CM Ratio =
Total contribution margin / Total sales dollars
incremental analysis
When the analysis of a change in profits only considers the costs and revenues that will change as the result of the decision, the decision is being made using
Changes in Sales Mix
`can affect the breakeven point, margin of safety and other factors
Margin of safety
`excess of budgeted (or actual) sales over the break-even sales; It is the amount by which sales can drop before losses are incurred
When a company sells one unit above the number required to break-even, the company's net operating income will
change from zero to a net operating profit
fixed total costs remain
constant
for every increase in sales after breakeven point, what will increase
contribution margin total net income
degree of operating leverage =
contribution margin / net operating income
After reaching the break-even point, a company's net operating income will increase by the
contribution margin per unit for each additional unit sold.
The calculation of contribution margin (CM) ratio is
contribution margin ÷ sales
CVP
cost volume profit analysis
A shift in the sales mix from high-margin items to low-margin items can cause total profit to
decrease
According to the CVP analysis model, profits would be increased by
decrease in the unit variable cost.
fixed costs for cost per unit
decreases with increase in activity
change in net income percent =
degree of operating leverage x percent of change in sales
When constructing a CVP graph, the vertical axis represents
dollars.
contribution margin per unit =
total contribution margin / number of units
contribution margin ratio =
total contribution margin / total sales
The break-even point is reached when the contribution margin is equal to
total fixed expenses
Break-even point is the level of sales at which
total revenue equals total costs
What is represented on the X axis of a cost-volume-profit (CVP) graph
unit volume
When preparing a CVP graph, the horizontal axis represents:
unit volume
The margin of safety is the excess
budgeted (or actual) sales dollars over break-even sales dollars.
total costs behaviors
fixed cost = constant variable cost = increases with increase in activity
cost per unit (activity driver)
fixed cost = decreases with increase in activity variable costs = constant
dollar sales to target profit =
fixed costs + target profit / contribution margin ratio
breakeven =
fixed costs / (selling price - variable cost)
breakeven units =
fixed costs / CM per unit
breakeven sales =
fixed costs / CM ratio
Contribution margin is first used to cover
fixed expenses
the high-low method
he rise-over-run formula for the slope of a straight line is the basis of
cost-volume-profit analysis (CVP)
helps managers make many important decisions such as what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to maintain
CVP analysis
helps managers make many important decisions such as what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to maintain. Its primary purpose is to estimate how profits are affected by the five factors
low fixed cost structure
income is higher in bad years (high variable costs)
