Cost Volume Profit analysis one of the most powerful tools that managers have at their disposal It helps managers understand the relationships among cost volume and profit by focusing on interactions among the following elements Cost Volume Profit o 1 Price of Products o 2 Volume or Activity Level o 3 Per unit Variable Cost o 4 Total Fixed Cost Because CVP analysis helps managers understand the interrelationships among cost volume and profit it is a vital tool in many business decisions These decisions include o 1 Deciding what products and services to offer o 2 Determining what pricing policy to follow o 3 Choosing a marketing strategy to employ o 4 Deciding what basic cost structure to use Basic CVP Analysis o 1 Break even calculations o 2 Target Profit Analysis o 3 Margin of Safety o 4 Operating Leverage o 1 Pay cover fixed costs o 2 Contribute towards profit Can be expressed in 3 ways Contribution Margin In order to understand CVP must first understand contribution margin represents the amount of revenue that is available to o 1 Total Contribution Margin sales revenue variable costs o 2 Contribution Margin per unit selling price unit variable cost unit o 3 As a percentage of sales contribution margin ratio C M Sales Revenue or C M per unit Selling Price per unit The break even point is where o No profit is earned o Sales variable costs fixed costs Why interested in Break even Point It aids in decision making by giving managers a minimum target revenue as well as providing some insight as to the viability of offering a new product or entering a new market The break even point units represents the units that must be sold to break The break even point in sales dollars represents the amount of sales revenue that must be earned to break even o Variable cost ratio V C Sales Revenue or V C per unit Selling Price per even unit o Since variable costs are a function of activity they will always be a constant percentage of sales The margin of safety is a measure of riskiness It measures the amount sales can fall before losses occur Margin of safety actual sales revenue break even sales revenue o The higher the margin of safety the lower the risk of reporting losses is a measure of how sensitive net income is to percentage Operating leverage changes in sales o Degree of operating leverage C M net income The degree of operating leverage is a measure at a given level of sales of how a percentage in sales volume will impact net income The degree of operating leverage tells us the percentage change in net income for every 1 change in sales Companies that produce more than one product the relative combination of products being sold by a firm Sales mix o Ex ABC Company sells 70 000 units of A and 30 000 units of B the sales Once the sales mix has been determined you should calculate the package mix is 7 3 contribution margin per unit o For each product take the product s contribution margin per unit and multiply that by its sales mix number then add these together o This calculation allows us to convert a multiple product problem into a single product CVP format
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