Chapter 5 accounting

Sales mix

relative proportions in which the company's products are sold. when there are more than one product use overall contribution margin ratio: overall contribution margin/ overall sales

Relation between contribution margin and net income

It gives the manager the ability to predict what profits will be at various activity levels without the necessity of preparing detailed income statements

Percentage change in net income

percentage change in dollar sales X degree of operating leverage = percentage change in net income

Contribution Margin

is the difference between total sales and total variable expenses Can also find it by the unit contribution margin times the number of units sold Unit contribution x Unit Sales Contribution Margin

Operating leverage

refers to the effect a given percentage increase in sales will have on net income

CVP analysis relies on the following

1. selling price per unit is constant, it does not change as unit sales change 2. Costs are linear and can be accurately divided into variable and fixed elements (variable cost per unit is constant and the total fixed cost is constant) 3. In multi-product situations, the sales mix is constant 4. In manufacturing companies, inventories do not change (units products=units sold)

Target profit analysis is used in two basic variations

1. variation: the manager would like to know HOW MANY UNITS would have to be sold to attain the target profit 2. Variation: the manager would like to know HOW MUCH TOTAL DOLLAR SALES would have to be to attain the target profits

CVP and break-even analysis can also be done graphically

A cost-volume profit graph shows the relations among sales, costs and volume throughout wide ranges of activity

The contribution margin ratio can be computed in two ways

CM ratio= contribution margin/sales CM ratio= Unit contribution margin/unit selling price

Contribution margin ratio used to predict the change in total contribution margin that would result from a given change in dollar sales

Change in dollar sales X CM ratio = Change in contribution margin An increase (or decrease) in contribution margin will be reflected dollar-for-dollar in increased (or decreased) net income, assuming that fixed expenses are not affected

Net Income

Contribution margin less fixed expenses Sales Less variable expense contribution margin less fixed expense Net income

Degree of operating leverage

Contribution margin/ net income

Unit sales to attain target profit

Fixed expenses + Target profit / Unit contribution margin

Dollar sales to attain target profit

Fixed expenses + Target profit/ CM ratio

CM ratio is particularly useful when a company has multiple products

In such situations, volume is most conveniently expressed int terms of total dollar sales rather than in units sold

Break even point can be defined either as

The point where total sales revenue equals total expenses (variable and fixed) The point where total contribution margin equals total fixed expenses

Once break even point is reached

Units above Break-even point x Unit contribution margin = net income

Two examples of cost-volume profit analysis (CVP)

break-even analysis and target profit analysis---often used by managers

Contribution margin ratio (CM ratio)

expresses the contribution margin as a percentage of sales, is another very powerful concept.

break-even point in total sales dollars

fixed expenses/Cm ratio

Break-even point in units sold

fixed expenses/unit contribution margin

unit contribution margin

is the difference between the unit selling price and the unit variable expense Selling price per unit less variable expense per unit unit contribution margin

margin safety

the excess of budgeted (or actual) sales over the break even volume of sales. It is the amount by which sales can drop before losses begin to be incurred. The margin of safety can be stated in terms of either dollars or as a percentage of sales Margin of safety= Total sales- break even sales

Target profit analysis

used when a manager would like to know how much the company would have to sell to attain a specific target Sales= variable expenses + fixed expenses + profits AT BREAK EVEN POINT PROFITS EQUAL ZERO