COST-VOLUME- PROFIT ANALYSIS

1. COST-VOLUME- PROFIT ANALYSIS

2. Cost-volume-profit (CVP) analysis is used to answer questions such as: How much must I sell to earn my desired income? How will income be affectedif I reduce selling prices toincrease sales volume? What will happen toprofitability if I expandcapacity? Cost-Volume-Profit Relationships

3. Total fixed costextends horizontallyfrom the vertical axis. Total fixed cost Preparing a CVP Graph • Starting at the origin, draw the total revenueline with a slope equal to the unit sales price. Revenue Costs and Revenuein Dollars Volume in Units

4. Preparing a CVP Graph Revenue • Draw the total cost line with a slopeequal to the unit variable cost. Break-even Point Profit Costs and Revenuein Dollars Total cost Loss Total fixed cost Volume in Units

5. The break-even point (expressed in units of product or dollars of sales) is the unique sales level at which a company neither earns a profit nor incurs a loss. Computing Break-Even Point

6. Computing Break-Even Point How many units must this company sell to cover its fixed costs(break even)? How much contribution margin must this company have to cover its fixed costs (break even)? Answer: $30,000 How many units must this company sell to cover its fixed costs (break even)? Answer: $30,000 ÷ $20 per unit = 1,500 units Contribution margin is amount by which revenue exceeds the variable costs of producing the revenue. How much contribution margin must this company have to cover its fixed costs (break even)?

7. Computing Break-Even Point The contribution margin income statement confirms the calculation.

8. We have just seen one of the basic CVP relationships – the break-evencomputation. Fixed costs Break-even point in units = Contribution margin per unit Formula for ComputingBreak-Even Sales (in Units) Finding the Break-Even Point Unit sales price less unit variable cost($20 in previous example)

9. ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to break even? a. 100,000 units b. 40,000 units c. 200,000 units d. 66,667 units Computing Break-Even Sales

10. Unit contribution = $5.00 - $3.00 = $2.00 Fixed costsUnit contribution $200,000$2.00 per unit = = 100,000 units Computing Break-Even Sales ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to break even? a. 100,000 units b. 40,000 units c. 200,000 units d. 66,667 units

11. Break-even formulas may be adjusted to show the sales volume needed to earnany amount of operating income. Computing Sales Needed to Achieve Target Operating Income Unit sales in order to achieve target income Fixed costs + Target income = Contribution margin per unit

12. Computing Sales Needed to Achieve Target Operating Income ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000? a. 100,000 units b. 120,000 units c. 80,000 units d. 200,000 units

13. Unit contribution = $5.00 - $3.00 = $2.00 Fixed costs + Target income Unit contribution $200,000 + $40,000 $2.00 per unit = 120,000 units Computing Sales Needed to Achieve Target OperatingIncome ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000? a. 100,000 units b. 120,000 units c. 80,000 units d. 200,000 units

14. Computing Sales Needed to Achieve Target OperatingIncome The contribution margin income statement confirms the calculation.

15. Fixed costs Break-even point in dollars = Contribution margin ratio Contribution margin per unit Unit sales price Formula for ComputingBreak-Even Sales (in Dollars) The break-even formula may also be expressed in sales dollars.

16. Computing Break-Even Sales Use the contribution margin ratio formula to determine the amount of sales revenue ABC must have to break even. All information remains unchanged: fixed costs are $200,000; unit sales price is $5.00; and unit variable cost is $3.00. a. $200,000 b. $300,000 c. $400,000 d. $500,000

17. Computing Break-Even Sales Use the contribution margin ratio formula to determine the amount of sales revenue ABC must have to break even. All information remains unchanged: fixed costs are $200,000; unit sales price is $5.00; and unit variable cost is $3.00. a. $200,000 b. $300,000 c. $400,000 d. $500,000 Unit contribution = $5.00 - $3.00 = $2.00 Contribution margin ratio = $2.00 ÷ $5.00 = .40 = 40% Break-even revenue = $200,000 ÷ 40% = $500,000

18. Break-even formulas may be adjusted to show the sales volume needed to earnany amount of operating income. Computing Sales Needed to Achieve Target Operating Income Unit sales in order to achieve target income Fixed costs + Target income = Contribution margin per unit Dollar sales in order to achieve target income Fixed costs + Target income = Contribution margin ratio

19. Margin of safety is the amount by which sales may decline before reaching break-even sales: Margin of safety provides a quick means of estimating operating income at any level of sales: Margin of safety = Actual sales ($) - Break-even sales ($) Operating Margin Contribution Income of safety margin ratio = × What is our Margin of Safety?

20. ADM Company’s contribution margin ratio is 40 percent. If sales are $100,000 and break-even sales are $80,000 what is operating income? Operating Margin Contribution Income of safety margin ratio = × Operating Income = $20,000 × .40 = $8,000 What is our Margin of Safety?

21. Once break-even is reached, every additional dollar of contribution margin becomes operating income: ADM Company expects sales to increase by $15,000 and has a contribution margin ratio of 40%. How much will operating income increase? Change in Change in Contributionoperating income sales volume margin ratio = × Change in operating income = $15,000 × .40 = $6,000 What Change in Operating Income Do We Anticipate?

22. Income Taxes Assuming that the motel’s tax rate is 45%. What operating income is required to achieve a $39,000 after-tax profit? Operating Income = Net Income (AT) / (100-Tax rate) = $39,000 / (100-45%) = $39,000 / (55%) = $70,909

23. Consider the following information developed by the accountant at Biken Inc., a bicycle retailer: Business Applications of CVP: Evaluating Marketing Strategy

24. Should Biken Inc. spend $12,000 on advertising to increase sales by 10 percent? Business Applications of CVP

25. 550 × $500 550 × $300 $80K + $12K Business Applications of CVP Should Biken Inc. spend $12,000 on advertising to increase sales by 10 percent?

26. Business Applications of CVP Now, in combination with the advertising, Biken Inc. is considering a 10 percent price reduction that willincrease sales by 25 percent. What is the income effect?

27. 1.25 × 500 625 × $450 625 × $300 $80K + $12K Business Applications of CVP Now, in combination with the advertising, Biken Inc. is considering a 10 percent price reduction that willincrease sales by 25 percent. What is the income effect?

28. Business Applications of CVP Now, in combination with advertising and a price cut, Biken Inc.will replace $50,000 in sales salaries with a $25 per bike commission, increasing sales by 50 percent above the original 500 bikes. What is the effect on income?

29. 1.5 × 500 750 × $450 750 × $325 $92K - $50K Business Applications of CVP Now, in combination with advertising and a price cut, Biken Inc.will replace $50,000 in sales salaries with a $25 per bike commission, increasing sales by 50 percent above the original 500 bikes. What is the effect on income? The combination of advertising, a price cut,and change in compensation increases income.