Accounting Chapter 7
reduce the unit's contribution margin. As a result, more units need to be sold to achieve a target profit
Higher variable costs have the same effect as lower sales prices --> they both....
Expected (or actual) sales in units / Breakeven
How do you calculate the margin of safety as a percentage?
Contribution margin / operating income
How do you calculate the operating leverage factor?
1. income statement approach 2. shortcut approach using the unit contribution margin 3. shortcut approach using the contribution margin ratio - all are based on the income statement - first 2 methods use sales units. Third method uses sales revenue (sales dollars)
3 ways to calculate the breakeven point:
1. Choose a sales volume (ex. 1,000 units --> 1,000 x $35 per unit = sales of $35,000). Draw the sales revenue line from the origin (0) through the $35,000 point. 2. Draw the fixed expense line - horizontal line that intersects the y-axis (ex. at 7,000 units) 3. Draw the total expense line - mixed cost (VC + FC). ($21,000 + $7,000 = $28,000. Draw a line through this point from the $7,000 fixed expense intercept on the dollars axis 4. Identify the breakeven point. this point is where the sales revenue intersects the total expense line. 5. Mark the operating income and the operating loss on the graph. To the left of the breakeven point --> expense line is above sales revenue. To the right of the breakeven point, the business earns a profit. - y-axis is the dollars and x-axis is the volume of units - graph helps managers visualize profit or loss over a range of volume
5 steps in drawing the Cost-Volume-Profit Graph:
Sensitivity analysis
A "what-if" technique that asks what results will be if actual prices or costs change or if an underlying assumption such as sales mix changes
Contribution margin per unit given current sales price of $35 ..... $14 Multiplied bu expected decline in volume (10% x 950 posters).... x 95 Expected decline in operating income if price is not reduced.... $ 1,330
Assuming a 10% decline in sales but you want to retain the sales price as $35. How do you calculate the expected decline in operating income?
low operating leverage companies reap less reward than high operating leverage companies experiencing the same volume increases at low operating leverage companies, changes in sales volume do not have as much of an impact on operating income as do changes at high leverage operating companies
Biggest difference between low operating leverage and high operating leverage:
1. Sales price - price charged for each unit 2. Volume - number of units sold 3. Variable costs - cost of units from suppliers 4. Fixed costs 5. Profit or Loss - company's operating income
CVP Analysis relies on the interdependency of 5 components:
- Determine the weighted-average contribution margin - determine sales in total units using the weight-average contribution margin per unit - multiple the sales in total units by ⅝ and ⅜ to determine how many posters you need to sell in each size NO! You must sell 219 regular and 132 large! You do this to avoid a loss.
Determine how you would calculate the breakeven point: - Regular poster sales price: $14 - Large poster sales price $30 - for every 5 regular's sold, she sells 3 large (regular: ⅝ and large ⅜) Another question: the breakeven sales come up at 218.75 regular and 131.25 large. Do we leave this alone?
NO - the breakeven point could be altered though
Do changes in fixed costs affect the contribution margin?
Cost-volume-profit - determine the sales volume to break-even or to cover costs - determine sales volume to earn a target profit - helps prepare and respond to economic changes (ex. increases in costs from suppliers)
Expresses the relationships among costs, volume, and the company's profit
It comes from the income statement by diving the total contribution margin by the total sales revenue. The contribution margin is already weighted by the company's actual sales mix
How do you calculate the weighted-average contribution margin ratio for a multi-product company?
Sales in dollars = (fixed expenses + operating income) / contribute margin ratio the target profit is $4,900 so you use that for operating income OR # of units x sales price per unit = sales revenue
How do you determine the sales revenue using the contribution margin ratio?
You calculate the breakeven in terms of sales revenue
How do you find the breakeven point for a company that offers thousands of products, such as Amazon or Walmart?
Fewer volume is needed to achieve the target profit
If fixed costs decrease, what happens to the breakeven point (sales in units)?
unit contribution margin goes down and the volume to break even or achieve a target profit goes up unit contribution margin goes up and the volume to break even or achieve a target profit goes down
If the sales price goes down, what happens to the unit contribution margin and the volume needed breakeven? If the sales price goes up, what happens to the unit contribution margin and the volume needed breakeven?
unit contribution margin goes down and the volume needed to break even or achieve a target profit goes up unit contribution margin goes up and the volume needed to break even or achieve a target profit goes down
If the variable costs increase, what happens to the unit contribution margin and the volume needed breakeven? If the variable costs decrease, what happens to the unit contribution margin and the volume needed breakeven?
Sales in units = (fixed expenses + operating income) / contribution margin per unit ^^^ the operating income would be your target profit. So say your goal is to make $4,900 in profits. You use $4,900 for operating income.
Instead of breaking even, you want to find out sales in units with a specific target profit in mind. What equation do you use?
Contribution Margin (sales revenue x contribution margin ratio (%)) minus fixed expenses
Managers can also use the contribution margin ratio to quickly predict operating income at different sales volumes within the relevant range. What would this equation look like?
Use the contribution margin to quickly predict operating income at any volume within their relevant range contribution margin (units x sales price) minus fixed expenses = operating income
Managers often want to predict operating income at different sales volumes. How do they do this?
Sales in dollars = (fixed expenses + operating income) / contribute margin ratio
Multiproduct companies usually calculate breakeven in terms of sales revenue (dollars). They use the shortcut approach using the contribution margin ratio. What is the equation:
Target profit
Profit goal, the target the managers are aiming to achieve
Operating leverage - ex. golf courses, airlines, and hotels
Refers to the relative amount of fixed and variable costs that make up its total costs
Contribution Margin sales revenue - variable costs = CM
Tells managers how much revenue is left - after paying variable expenses - to contribute toward the company's fixed expenses and operating income
Operating Leverage Factor - "at a given level of sales" = current or expected volume of sales - indicates the percentage change in operating income that will occur from a 1% change in sales volume
Tells managers how responsive a company's operating income is to changes in sales volume.
Sales Mix / "basket of products" ex. 15% posters, 25% unframed photos, and 60% framed prints - a company earns more operating income by selling high-contribution margin products than by selling an equal number of low-contribution margin products
The combination of products that make up total sales
Margin of safety - the "cushion," or drop in sales, the company can absorb without incurring a loss - the higher the margin of safety, the greater the cushion against loss and the less risky the plan is
The excess of actual or expected sales over the sales needed to breakeven
Contribution margin per unit OR unit contribution margin - important - shows how much profit is made on each unit before considering fixed costs - the higher the contribution margin per unit, the more profitable each unit is - all variable costs, whether product costs or period costs, are included when calculating contribution margin per unit
The excess of the selling price per unit over the variable cost per unit
1, which occurs only if the company has no fixed costs
The lowest possible value for the operating leverage factor is.....
Contribution Margin Ratio - contribution margin per unit / sales price per unit OR contribution margin / sales revenue - ex. 40% --> each $1 of sales revenue contributes $0.40 to pay for fixed expenses and generate profit. The remaining $0.60 is used to pay for variable costs
The ratio of contribution margin of sales revenue
Breakeven point - sales revenue equal total expenses
The sales level at which operating income is zero
With a sales mix, the formulas use the weighted-average contribution margin of all products rather than the contribution margin of a sole product - weighted by the relative number of units sold
The same CVP formulas that are used to perform CVP analysis for a company with a single product can be used for any company that sells more than one product. What is the difference though?
companies have more fixed costs and relatively fewer variable costs - because they have fewer variable costs, their contribution margin ratio is relatively high - however, if sales volume decreases, the total contribution margin will drop significantly because each sales dollar contains a high percentage of contribution margin. they are still paying high FC - companies are more at risk because their income declines drastically when sales volume declines. have less money to contribute to fixed costs - if sales volume increases, the company will reap high rewards. They will have higher contribution ratios and more money to contribute to the firm's operating income
What does it mean to have high operating leverage?
companies have fewer fixed costs and relatively more variable costs - lower contribution margins - more of every sales dollar is used to pay for VC, so less ends up as a contribution margin. If sales volume declines, they have relatively fewer fixed costs to cover, so they are at less risk of incurring a loss
What does it mean to have low operating leverage?
the operating leverage factor is also higher. the larger the operating leverage factor is, the greater the impact a change in sales volume has on operating income (true for increases and decreases in volume)
What happens to the operating leverage factor when there are more fixed costs?
Sales in units = (fixed expenses + operating income) / contribution margin per unit
What is the equation for the shortcut approach using the unit contribution margin?
The higher the contribution margin per unit, the less volume needed vice versa - The lower the contribution margin per unit, the more volume needed
What is the importance of the trade-off between the unit contribution margin and volume?
sales revenue (sales price per unit x units sold) - variable expenses (variable cost per unit x units sold) - fixed expenses = operating income
income statement approach equation: