copyright © 2008 prentice hall all rights reserved 7-1 cost-volume-profit analysis chapter 7

Copyright © 2008 Prentice Hall All rights reserved

7-1

Cost-Volume-Profit Analysis

Chapter 7


7-2

Objective 1

Calculate the unit contribution margin and the contribution

margin ratio


7-3

Components of CVP Analysis

• Sales price per unit

• Volume sold

• Variable costs per unit

• Fixed costs

• Operating income


7-4

CVP Assumptions

1. Change in volume is only factor that affects costs

2. Managers can classify each cost as either variable or fixed• These costs are linear throughout relevant range

3. Revenues are linear throughout relevant range

4. Inventory levels will not change

5. The sales mix of products will not change


7-5

Unit Contribution Margin

Sales price per unit

- Variable costs per unit

Contribution margin per unit

Example:

Sales Price per Poster $35

Less: Variable Cost per poster (21)

Contribution Margin per poster $14


7-6

Contribution Margin Ratio

Unit contribution margin

Sales price per unit

Example:

Unit contribution margin $14 = 40%

Sales price per unit $35


7-7

Objective 2

Use CVP analysis to find breakeven points and target profit

volumes


7-8

Breakeven Point

• Sales level at which operating income is zero

• Sales above breakeven result in a profit

• Sales below breakeven result in a loss


7-9

Income Statement Approach

Contribution Margin Income Statement

Sales

- Variable Costs

Contribution Margin

- Fixed Costs

Operating Income


7-10

Short-Cut Approach Using the Unit Contribution Margin

Fixed expenses + Operating income Contribution margin per unit

Units sold =


7-11

Short-Cut Approach Using the Unit Contribution Margin Ratio

Fixed expenses + Operating income Contribution margin ratio

Sales in $ =


7-12

E7-15 1.

Contribution margin ratio =

Contribution margin ÷ Sales =

$187,500 ÷ $312,500 = 60%


7-13

E7-15 1.

Aussie TravelContribution Margin Income Statements

Sales revenue $250,000 $360,000Variable expenses (40%) 100,000 144,000Contribution margin $? $?Fixed expenses 170,00 170,000Operating income (loss) $ (20,000) $46,000

Hint: Contribution margin income statements are

produced by using the different volume levels and the

calculated variable expenses.


7-14

E7-15 2.

Fixed expenses + Operating income Contribution margin ratio

Sales in $ =

$170,000 + $060%

Sales in $ = = $283,333


7-15

E7-17 1.

Contribution margin = Sales–Variable costs

= $1.70 - $0.85

= $0.85

Contribution margin ratio:Contribution margin per unit $0.85

Sales price per unit $1.70= = 50%


7-16

E7-17 2.

Breakeven sales in units:

Fixed costs + Operating income

?

($85,000 + $0) / ? = 100,000 units


7-17

E7-17 2.

Breakeven sales in dollars:


Contribution margin ratio

($85,000 + $0) / 50% = $170,000


7-18

E7-17 3.

Sales in units:


Contribution margin per unit

($85,000 + $25,000) / $0.85 = 129,412 units


7-19

Graphing the CVP Relationships

Step 1: Choose a sales volume Plot point for total sales revenue Draw sales revenue line from origin through

the plotted point


7-20

Preparing a CVP Chart

$0

$5,000

$10,000

$15,000

$20,000

0 500 1,000 1,500

Volume of Units

Do

llars

Revenues•


7-21


Step 2: Draw the fixed cost line


7-22


$0

$5,000

$10,000

$15,000

$20,000

0 500 1,000 1,500

Volume of Units

Do

llars

Revenues

Fixed costs


7-23


Step 3: Draw the total cost line

Hint: What are the two factors that comprise the Total Cost of operations?


7-24


$0

$5,000

$10,000

$15,000

$20,000

0 500 1,000 1,500

Volume of Units

Do

llars Revenues

Fixed costs

Total cost


7-25


Step 4: Identify the breakeven point and the areas of

operating income and loss

Hint: When does a

company “break even”?

When the neither make money or lose

money….


7-26


$0

$5,000

$10,000

$15,000

$20,000

0 500 1,000 1,500

Volume of Units

Do

llars

Breakeven point


7-27


Step 5: Mark operating income and operating loss

areas on graph


7-28


$0

$5,000

$10,000

$15,000

$20,000

0 500 1,000 1,500

Volume of Units

Do

llars

Breakeven point

Operating income

Operating Loss


7-29

E7-24

$-

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

0 600 1,200 1,800 2,400

Tickets (in thousands)

Do

llars

(in

th

ou

san

ds)

Revenues


7-30

E7-24

$-

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

0 600 1,200 1,800 2,400


Do

llars

(in

th

ou

san

ds)

Fixed Costs

Revenues


7-31

$-

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

0 600 1,200 1,800 2,400


Do

llars

(in

th

ou

san

ds)

E7-24

Breakeven point

Total CostsFixed Costs

Revenues


7-32

$-

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

0 600 1,200 1,800 2,400


Do

llars

(in

th

ou

san

ds)

Operating

Loss

Operating

income

E7-24

Total Costs

Revenues


7-33

E7-24

($24 x units sold)-($4 x units sold)-$24,000,000 = $0

($20 x units sold) = $0 + $24,000,000

Units sold = $24,000,000 ÷ $20 = 1,200,000 tickets

1,200,000 x $24 per ticket = $28,800,000


7-34

Objective 3

Perform sensitivity analysis in response to changing business

conditions


7-35

Sensitivity Analysis

• “What if” analysis

• What if the sales price changes?

• What if costs change?

• What if the sales mix changes?


7-36

E7-25

Sales needed to Breakeven =

Fixed Costs ÷ Contribution Margin Ratio

$500,000 = Fixed Costs ÷ .40

$500,000 × .40 = Fixed Costs

$200,000 = Fixed Costs

New fixed costs = $240,000


7-37

E7-25

Sales needed to Breakeven =

Fixed Costs ÷ Contribution Margin Ratio

$240,000 ÷ .40 = $600,000


7-38

E7-26

Sale price per scarf $16

Contribution margin ratio x.625

Contribution margin per unit $10

Scarves needed to pay for extra entrance fee cost of $150 ($1,000 x 15%):

$150 ÷ $10 = 15 scarves


7-39

Objective 4

Find breakeven and target profit volumes for multiproduct

companies


7-40

Multiple Product Break-Even Point – E7-28

Step 1: Calculate weighted-average contribution marginStandard Chrome Total

Sale price per unit $54 $78

Variable costs per unit 36 50

Contribution margin per unit $18 $28

Sales mix in units x 3 x 2

Contribution margin $54 $56 $110

Weighted average contribution

Margin per unit ($110 / 5) $22


7-41


Step 2: Calculate the breakeven point in units


Weighted average contribution margin per unit

(? + ?) ÷ ? = 440 composite units


7-42


Step 3: Calculate the breakeven point in units for each product line

Standard: 440 units x 3/5 = 264 units

Chrome: 440 units x 2/5 = 176 units


7-43

E7-28

To earn $6,600


Weighted average contribution margin per unit

($9,680 + $6,600) ÷ $22 = 740 composite units

Standard: 740 x 3/5 = 444

Chrome: 740 x 2/5 = 296


7-44

Objective 5

Determine a firm’s margin of safety and operating leverage


7-45

Margin of Safety

• Excess of expected sales over breakeven sales

• Drop in sales that the company can absorb before incurring a loss

• Used to evaluate the risk of current operations as well as the risk of new plans


7-46

Margin of Safety

Margin of Safety in Units =Expected sales in units – Breakeven sales in units

Margin of Safety in Dollars =Margin of safety in units x Sale price per unit


7-47

Margin of Safety

Margin on safety as a percentage is the same whether units or dollars are used

Margin of safety in units ÷ Expected sales in units

Margin of safety in dollars ÷ Expected sales in $


7-48

E7-33 1.

Margin of safety = Expected sales – breakeven sales

Expected sales: Sales – variable costs – fixed costs = operating income

Sales – 70% Sales - $9,000 = $12,000

30% Sales = $9,000 + $12,000

Sales = $70,000


7-49

E7-33 1.


Breakeven sales: Sales – variable costs – fixed costs = operating

incomeSales - 70% x Sales - $9,000 = $030% Sales = $9,000Sales = $30,000


7-50

E7-33 1.


= $70,000 - $30,000

= $40,000


7-51

E7-33 2.

Margin of safety as a % of target sales =

$40,000 ÷ $70,000 = 57%


7-52

Operating Leverage

• Relative amount of fixed and variable costs that make up total costs

• Operating leverage factor:

Contribution margin

Operating income

Indicates percentage change in operating income that will occur from a 1% change in volume


7-53

Characteristics of High Operating Leverage Firms

• High operating leverage companies have:– Higher levels of fixed costs and lower levels of variable costs

– Higher contribution margin ratios

• For high operating leverage companies, changes in volume significantly affect operating income, so they also face:

– Higher risk

– Higher potential for reward

• Examples include: golf courses, hotels, rental car agencies, theme parks, airlines, cruise lines


7-54

Characteristics of Low Operating Leverage companies

• Low operating leverage companies have:– Higher levels of variable costs, and lower levels of fixed costs

– Lower contribution margin ratios

• For low operating leverage companies, changes in volume do NOT have as significant an affect on operating income, so they face:

– Lower risk

– Lower potential for reward

• Examples include: merchandising companies


7-55

Operating Leverage Factor

Contribution margin

Operating income

As a general rule, the operating leverage factor, at a given level of sales, indicates

the percentage change in operating income that will occur from a 1% change

in volume


7-56

E7-33 3.

Sales $70,000

Variable costs (70%) 49,000

Contribution margin $21,000

Operating leverage:

Contribution margin ÷ Operating income

$21,000 ÷ $12,000 = 1.75


7-57

E7-33 4.

If volume decreases 10%, income will decrease: 10% x 1.75 = 17.5%


7-58

End of Chapter 7

copyright © 2008 prentice hall all rights reserved 7-1 cost-volume-profit analysis chapter 7

Documents

breakeven sales

unit contribution marginshort

unit variable costs

cvp chartstep

cvp chartpreparing

operating income loss

areas of operating income

cvp relationshipsstep