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