ACTG 3020

Chapter 6 - Cost-Volume-Profit Relationships

Contribution Margin

• Sales - Variable Costs

• Per unit – Sales Price per unit - var. costs per unit– Tells us how much in $ is contributed to firm

• Ratio– CM per unit/Sales price per unit– Tells us what % of each dollar is contributed to

the firm

Example of Contribution Margin

• Racer Rick’s Bicycles (Sales of 200 bikes)

• Sales Revenues $100,000

• Var. Costs 40,000

• Contr. Margin 60,000

• Less Fixed costs 30,000

• Net Income $30,000

Contribution Margin

• CM in total = $60,000

• CM per unit = – $100,000/200 bikes = $500 sales price per bike– $ 40,000/200 bikes = $200 var.costs per bike– $ 60,000/200 bikes = $300 CM per bike

• CM Ratio =– $300/$500 = 60% OR– $60,000/$100,000 = 60%

Net Income if 1 more bike sold

• Sale of 201 bikes

• Sales Revenues $100,500 (201 x $500)

• Var. Costs 40,200 (201 x $200)

• Contribution Margin 60,300

• Less fixed costs 30,000

• Net income $30,300

• Sales of one more unit = $300 increase in Net Income (due to contribution margin)

How Changes Affect CM

• Changes in sales price– Increase, CM increases– Decrease, CM decreases

• Changes in variable costs– Increase, CM decreases– Decrease, CM increases

• Changes in fixed costs– Increase or decrease, no change in CM

Break-Even Analysis

• Break-even (Point where Net Income = 0)

• Sales = Variable costs + Fixed costs

• How many bikes do we need to sell in order to break-even?

• 2 methods – Equation method– Contribution margin method

Break-even Analysis

• Equation Method• Sales = Var. Costs +

Fixed Costs• $500x = $200x +

$30,000• $300x = $30,000• x = 100 bikes

• Check• Sales $50,000 (100

x $500) • Var. Costs 20,000

(100 x $200)• CM $30,000• - Fixed 30,000 • Net Income -0-

Break-even Analysis

• Contribution Margin Method

• 1) Determine the CM per unit

• $500 - $200 = $300

• 2) Calculate how many units must be sold to break even by the following formula:

• Fixed costs $30,000 = 100 bikes

• CM per unit $300

Break-even Analysis

• In Sales Dollars

• B.E. in units x Sales price per unit

• 100 units X $500 = $50,000

• OR

• Fixed Costs

• CM ratio = $30,000/60% = $50,000

How Changes Affect Break-even Point

• Changes in sales price– Increase, BEP decreases– Decrease, BEP increases

• Changes in variable costs– Increase, BEP increases– Decrease, BEP decreases

• Changes in fixed costs– Increase , BEP increases– Decrease, BEP decreases

Who wants to break even?

• Target Profit Analysis

• Add Profit to previous equations

• Profit is treated just like a fixed cost

Target Profit AnalysisAdd desired profit to fixed costs

• Equation Method• $500x = $200x +

$30,000 fixed + $60,000 Desired profit

• $300x = $90,000• x = 300 bikes

• Contribution Margin Approach

• $30,000 + $60,000• $300 • = $90,000/300 =• 300 bikes

Margin of Safety

• Current sales

• - Break-even sales

• = Margin of safety

• Tells you how far sales can drop before you have no net income. Indicates a safety cushion.

Cost Structure- what portions of costs are fixed or variable

• Company 1 - Pizza Pizza

• Sales $200,000• -Var. costs 150,000• CM 50,000• -Fixed costs 20,000• Net income 30,000

• Company 2 - Pizza oven manufacturers

• Sales $200,000• -Var. costs 50,000• CM 150,000• -Fix. costs 120,000• Net income 30,000

Cost Structure

• What is CM ratio for each company?

• Company 1 = 50,000/200,000

• Company 2 = 150,000/200,000

• Which company is riskier?

• Operating Leverage = Contribution Margin Net Income

• Higher operating leverage, more risky company

Sales Mix

• Sales Mix– Sell more than one product– Compute contribution ratio for entire company– Break-even analysis is then computed using the

regular equations– If actual sales mix is different than predicted,

break-even analysis and profit calculations will be different than predicted.