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)