BMGT221 G Pfeiffer Chapter 7 1 A How Does Cost Volume Profit Analysis Help Managers o Cost Volume Profit Analysis expresses the relationship between costs volume and profit or loss Data Required for Effective CVP Analysis o CVP data relies on the interdependency of 5 components a Sales price b Volume c Variable costs d Fixed costs e Profit or loss o How changes in any of the components will affect their business CVP Assumptions o CVP analysis assumes the following a A change in volume is the only factor that affects costs b Managers can classify each cost or the components of mixed costs as either variable or fixed These costs are linear throughout the relevant range of volume c Revenues are linear throughout the relevant range of volume d e The sales mix of products wont change Inventory levels wont change Sales Mix combination of products that make up total sales The Unit Contribution Margin o Contribution Margin Income Statement separates costs by behavior rather a Information for the CVP analysis is presented in a ready to use format o Contribution Margin tells managers how much revenue is left after paying than function variable expenses a CM Excess of SR Variable Expenses b Stated as a total amount on the CM income statement o Contribution Margin per unit indicate how much profit each unit provides before fixed costs are considered a aka unit contribution margin b Some businesses pay sales commission on each unit or have other variable expenses i e shipping c CM per unit SR per unit Variable Cost per unit Sales Price per poster 35 Less Variable Cost per poster 21 Gross Profit 14 o Managers can use the unit CM to forecast income at any volume within their relevant range BMGT221 G Pfeiffer Chapter 7 2 CM Margin 650 posters x 14 per poster 9 100 Less Fixed Expenses 7 000 Operating Income 2 100 The Contribution Margin Ratio o Contribution Margin Ratio ratio of Contribution Margin to Sales Revenue o The percentage of each sales dollar that is available for covering fixed expenses and generating a profit a CM Margin Ratio Unit CM SR per unit OR b CM Margin Ratio CM SR o Managers can use the CM ratio to forecast operating income within the relevant range a Project income based on sales dollars not sales units CM margin 70 000 sales x 40 28 000 Less Fixed Expenses 7 000 Operating Income 21 000 B How do Managers Find the Breakeven Points o Breakeven Point the sales level at which operating income is zero a Sales below the breakeven point result in a loss b Sales above the breakeven point provide a profit o 3 ways to calculate the breakeven point a The Income Statement Approach b The shortcut approach using the unit contribution margin c The shortcut using the contribution margin ratio o All three approaches are based on the income statement so they arrive at the o To recall which shortcut gives which result a Dividing fixed costs by the unit CM Breakeven point in b Diving fixed costs by the CM ratio Breakeven point in same conclusion units dollars The Income Statement Approach o Starts with the contribution margin income statement and then breaks it into smaller components o Find breakeven point in terms of sales units BMGT221 G Pfeiffer Chapter 7 3 SR Variable Expenses Fixed Expenses Operating Income Sales Price per unit x Units Sold Variable Cost per unit x Units Sold Fixed Expenses Operating Income o You can check your answer by substituting the breakeven number of units into the income statement and checking that this level of sales results in zero profit Sales Revenue 500 posters x 35 17 500 Less Variable Expenses 500 posters x 21 10 500 Contribution Margin 7 000 Less Fixed Expenses 7 000 Operating Income 0 The Shortcut Approach Using the Contribution Margin o Start with the contribution margin income statement and rearrange some of its terms o Find breakeven point in terms of sales units SR Variable Expenses Fixed Expenses Operating Income Contribution Margin Fixed Expenses Operating Income Contribution Margin Fixed Expenses Operating Income Contribution Margin per unit x Units sold Fixed Expenses Operating Income o Divide both sides of the equation by contribution margin per unit a Sales in Units Fixed Expenses OI CM per unit The Shortcut Approach Using the Contribution Margin Ratio o Finds the breakeven point in terms of sales dollars a Multiproduct companies usually compute breakeven in terms of sales dollars not units b Sales in Units Fixed Expenses OI CM Ratio SR Variable Expenses Fixed Expenses Operating IncomeSales Price per unit x Units Sold Variable Cost per unit x Units Sold Fixed Expenses Operating IncomeSR Variable Expenses Fixed Expenses Operating IncomeContribution Margin Fixed Expenses Operating IncomeContribution Margin Fixed Expenses Operating IncomeContribution Margin per unit x Units sold Fixed Expenses Operating Income BMGT221 G Pfeiffer Chapter 7 4 C How Do Managers Find the Volume Needed to Earn a Target Profit o For established products and services more interested in sales level needed to earn a target profit than in a breakeven point o New businesses are also interested in expected profits How Much Must We Sell to Earn a Target Profit o Any of the methods can be used pick method based on whether you want the answer in sales dollars or units a Sales in Units Fixed Expenses OI CM per unit b Instead of OI zero insert target profit Graphing CVP Relationships o Graphing the CVP relationships allows companies to see how changes in the level of sales will affect profits o 5 steps to graph CVP relations a Step 1 choose sales volume i e 1000 posters Plot the point for total sales at that volume 1000 posters x 35 Draw the Sales Revenue Line from the origin through the 35 000 sales of 35 000 point Starts at the origin because if no posters are sold there is no SR b Step 2 Draw the Fixed Expense Line Fixed Expense Line a horizontal line that intersects the y axis at the expense amount Line is flat because expenses are the same no matter how many units are sold c Step 3 Draw the Total Expense Line Total Expenses the sum of fixed and variable expenses mixed cost Follows the form of the mixed cost line Compute Variable Expense at the chosen sales volume 1000 posters x 21 variable expense of 21 000 Add variable and fixed expenses 21 000 7 000 28 000 Plot the total expense point for 1 000 units Draw a line through this point from the 7 000 fixed expense intercept on the dollars axis d Step 4 Identify the Breakeven Point Point where the SR Line intersects the Total
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