acc212 ch 5

Degree of Operating Leverage

- a measure, at any given level of sales, of how a percentage change in sales volume will affect profits DOL = CM / NOI

Equation Method

- goal is to solve for unknown 'Q' which represents the quantity of units that must be sold to attain the target profit Profit = (P x Q - V x Q) - FC Profit = (P - V) x Q - FC Profit = Unit CM x Q - FC

Margin of Safety

- helps management assess how far above or below the break-even point the company is currently operating - the higher the margin of safety, the lower the risk of not breaking even and incurring a loss

Formula Method

- short cut version of the equation method - Unit Sales to Attain Target Profit = Target Profit + FC / CM per unit - $ sales to Attain Target Profit = Target Profit + FC / CM per unit

Contribution Margin Ratio

- shows how the contribution margin will be affected by a change in total sales CM Ratio = CM / Sales CM Ratio = CM per unit / selling price per unit

Break-Even Point

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

Break-Even in Units / $ Sales

Fixed Costs / unit CM

CVP Graph

highlights relationships among revenue, cost, profit, and volume over wide ranges of activity

Contribution Margin

the amount remaining from sales revenue less variable costs; the amount contributes toward covering fixed expenses and then toward profits for the period

CVP Analysis

tool that helps managers understand the relationships among cost, volume, and profit

Variable Expense Ratio

total variable expenses / total sales (in single approach analysis) variable cost per unit / unit selling price

Break-Even Point on CVP Graph

where the total revenue and total expenses lines intersect

2 Ways to Compute # of Units to Attain a Target Profit

1. Equation Method 2. Formula Method

Contribution Margin per Unit

CM per unit = Selling price per unit - VC per unit CM per unit = P - V

Margin of Safety %

Margin of Safety in $ / Sales

Margin of Safety in Units

Margin of Safety in $ / Selling Price

Profit (NOI)

Profit = (Sales - VC) - FC

Relationship Between Profit & CM Ratio Equation

Proft = (CM Ratio x Sales) - FC

Margin of Safety Formula

Sales - Break Even Sales

Operating Leverage

a measure of how sensitive net operating income is to percentage changes in sales

Break-Even Analysis

a special case of target profit analysis in which the target profit is zero

incremental analysis

consider only those items of revenue, cost, and volume that will change if the new program is implemented

Target Profit Analysis

estimate what sales volume is needed to achieve a specific target profit