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Cost-Volume-Profit Relationships

Explore the intricacies of Contribution Analysis in Cost-Volume-Profit relationships. Learn how to calculate break-even points, assess multiple volume scenarios, and make informed decisions based on variable costing. Understand the implications of different sales scenarios and product mixes on operating income and profitability. Dive into decision-making processes and evaluate the impact of promotional campaigns, price elasticity, and sales mix in multi-product companies. Enhance your understanding with comprehensive tutorials and real-life examples in this detailed analysis.

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Cost-Volume-Profit Relationships

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  1. Cost-Volume-Profit Relationships

  2. April 19, 2010 • A deeper look at Contribution Analysis • Break even • Cost-Volume-Profit • Variable Costing and Decision Making

  3. Contribution Analysis • Below is a Contribution Income Statement for the Go Fast Car Company • The Contribution Margin is $52 million, $4,727 per unit, or 39% • With this analysis in place, we can test different volume scenarios

  4. Calculating Break Even • Under a Contribution Analysis framework, calculating break-even becomes very straight forward • Break Even Volume = Fixed Costs / Unit Contribution Margin • Break Even Sales = Break Even Volume * Unit Sales Price • At sales volume of $96.5 million, Go Fast Car Co will make $0 • For every additional sale, the company will add $4.7k to its operating income

  5. Total CM Total sales CM Ratio = Contribution Margin Ratio • The Contribution margin ration is: • For Go Fast Car Co • 52,000,000 / 132,000,000 = 39% • For every additional $1 sold, the company will see 39 cents go to Operating Income

  6. Multiple Volume Scenarios & Cost Volume Profit • The Variable Cost Model allows us to easily test a multitude of volume scenarios and assess the impact on income • What would Operating Income be at unit sales of 20,000? • Graph the company’s CVP (X axis -$s; Y axis – units)

  7. Assumptions and Shortcomings • The Contribution Model can be very helpful, but it does make a number of simplifying assumptions • Selling price is constant • Costs are linear • Sales/product mix is constant • Inventories do not change (production = sales) • Ultimately, reliable models will be much more detailed • Nonetheless, and certainly within certain bounds, these concepts are most helpful

  8. Decision Making • The VP Sales wants to undertake a $3 million promotional campaign • How many more cars would Go Fast have to sell to justify that level of expenditure?

  9. Decision Making • Analysis of how many cars would need to be sold to justify a $3 million promotional expenditure • In this case, if the VP Sales signed up to selling more than 635 incremental cars, the company should proceed • The VP Sales compensation should be driven by the success of this • Of course, the company would only do this for substantially more than break even

  10. Decision Making • An economist reported that demand for Go Fast’s cars is highly elastic • A decrease in price of 2% would increase unit sales volume by 10% • Would Go Fast Car Co be better off by doing this?

  11. Decision Making • Analysis of a 2% decrease in price resulting in 10% increase in unit sales • Results in a decrease in Contribution per car, but an increase in operating income

  12. Multi-Product Companies and Sales Mix • Analysis of a multi-product company • What is break-even? • Which product would the company rather sell and why?

  13. Multi-Product Companies and Sales Mix • Break even sales = Fixed Costs/Contribution Ratio • $53 million / .36 = $147 million • The company would rather sell a car as they contribute more in absolute dollars and profitability

  14. Review • A deeper look at Contribution Analysis • Break even • Cost-Volume-Profit • Variable Costing and Decision Making

  15. Tutorial

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