Cost Volume Profit Analysis Chapter 6

1. Breakeven Analysis • Differential Cost Analysis Cost Volume Profit AnalysisChapter 6 INTRODUCTION The Profit Function

2. The Profit Equation Operating Profit Total Revenue Total Costs = – Operating profit equals total revenue less total costs.

3. The Profit Equation Operating Profit Total Revenue Total Costs = – = TR – TC

4. The Profit Equation Total Revenue Average Selling Price Per Unit Units of Output = × TR = P × X

5. The Profit Equation Total Costs Variable Costs Per Unit Units of Output Fixed Costs + = × TC = (V × X) + F

6. The Profit Equation Now, we’ll expand our original equation for profits! (P × X) - [(V × X) + F] =

7. The Profit Equation Now, we’ll expand our original equation for profits! (P × X) - [(V × X) + F] = (P – V)X – F =

8. Example Here is the information from the Hap Bikes:

9. Example (P – V)X – F =

10. Finding Target Volumes The formula to find a volume expressed in units for a target profit is . . . Target Volume (units) Fixed costs + Target profit Contribution margin per unit = How many bikes must Hap sell to earn an annual profit of $100,000?

11. Finding Target Volumes Target Volume (units) Fixed costs + Target profit Contribution margin per unit =

12. Proof If Hap sells 900 bikes, its operating profit would be . . . (P – V)X – F =

13. Finding the Break-Even Point The Break-Even Point is the volume level where profits equal zero. • To find the break-even point in units, we use the target volume in units equation and set the profit to zero. • To find the break-even point in sales dollars, we use the target volume in sales dollars equation and set the profit to zero.

14. Break-Even in Units Let’s use the Hap Bikes information again. Contribution margin ratio

15. Break-Even in Units Break-Even Volume (units) Fixed costs + Target profit Contribution margin per unit =

16. Break-Even in Sales Dollars Break-Even Volume (sales $) Fixed costs + Target profit Contribution margin ratio = $80,000 + $0 .40 =

17. Target Volume in Sales Dollars We can calculate the target volume in sales dollars using the contribution margin ratio. Contribution margin per unit Sales price per unit

18. Target Volume in Sales Dollars The equation for finding the target volume in sales dollars is . . . Target Volume (sales $) Fixed costs + Target profit Contribution margin ratio =

19. Graphic Presentation Consider the following information for Hap Bikes:

20. Graphic Presentation Dollars Volume per period (X)

21. Graphic Presentation Dollars Break-even point Volume per period (X)

22. Using CVP to Analyze Different Cost Structures • Cost structure - The proportion of fixed and variable to total costs of an organization. • Operating leverage - The extent to which an organization’s costs structure is made up of fixed costs. Let’s look at an example of different costs structures for different companies.

23. Using CVP to Analyze Different Cost Structures

24. Using CVP to Analyze Different Cost Structures Let’s see what happens when both companies experience a 10% increase in sales.

25. Using CVP to Analyze Different Cost Structures

26. Margin of Safety • Excess of projected (or actual) sales over the break-even volume. • The amount by which sales can fall before the company is in the loss area of the break-even graph. Sales Break-even volume sales volume – = Margin of Safety

27. Margin of Safety Hap is currently selling 500 bikes, and we calculated the break-even to be 400 units ($80,000 fixed costs ÷ $200 contribution margin).