1 / 40

CVP Analysis: Cost-Volume-Profit Tool for Short-Term Decision Making

CVP Analysis helps managers understand the relationships between cost, volume, and profit in an organization. This analysis focuses on factors such as prices, level of activity, variable and fixed costs, and sales mix. It is a valuable tool for short-term decision making.

georgetaylor
Download Presentation

CVP Analysis: Cost-Volume-Profit Tool for Short-Term Decision Making

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. chapter 3 cost volume profit analysis

  2. Short Term Decision Making • CVP Analysis • Contribution Margin (CM) • CM Ratio • Breakeven Analysis – CM & Equation method • Target Profit • Margin of Safety • CVP Graphs • Assumptions of CVP • Sales mix • Separating fixed and variable costs (hi-low) • Class Questions – Autoclean

  3. CVP Analysis • CVP Analysis helps managers to understand the interrelationship between cost, volume and profit in an organisation by focusing on the interactions between the following; • Prices of products • Volume or level of activity • Per unit variable costs • Total fixed costs • Mix of products sold • CVP Analysis is a vital tool for managers • …but it is only useful in the short-term

  4. Example: Wind Bicycle Company • You are given the following information about Wind Bicycle Company SAR/£ • Sales Amount 250,000 • Sales Unit 500 units • Fixed Costs 80,000 • Variable Costs 150,000

  5. CVP Basics: What is contribution margin (CM)? Contribution margin is the amount remaining from sales revenue after variable expenses have been deducted.

  6. CVP Basics: What is contribution margin (CM)? Contribution goes to cover fixed expenses. After covering fixed costs, any remaining contribution ‘contributes’ to profit.

  7. Contribution Margin (CM) Ratio CM Ratio = Contribution Margin Sales

  8. CM Ratio in Wind Bicycle Co. CM Ratio = Contribution Margin Sales CM Ratio = 200 = 0.4 or 40% in Wind 500 • Each SAR1.00 increase in sales revenue results in a total contribution margin increase of SAR0.40 • If sales increase by SAR50,000, what will be the increase in total contribution margin?

  9. Use of CM Ratio in Wind Bicycle Co. A SAR50,000 increase in sales revenue results in a SAR20,000 increase in CM. (SAR50,000 × 40% = SAR20,000)

  10. Changes in fixed costs and sales volume • Wind is currently selling 500 bikes per month • The company’s sales manager believes that an increase of SAR10,000 in the monthly advertising budget would increase bike sales to 540 units • Should we authorise the requested increase in the advertising budget?

  11. Changes in fixed costs and sales volume SAR80,000 + SAR10,000 advertising = SAR90,000 500 * 540 300 * 540 200 * 540 Sales increased by SAR20,000, but net profit decreased by SAR2,000.

  12. Changes in fixed costs and sales volume The shortcut solution:

  13. Breakeven Analysis • A key feature of CVP model is the ‘Break-Even Point’ (BEP) • At BEP all income equals all expenditure & the firm neither makes a profit or a loss • 2 approaches to calculating BEP (1) Equation method (2) CM method

  14. Calculating the BEP Equation method BEP in units = Fixed Costs Contribution per unit CM Margin Method Monetary BEP = Fixed Costs CM Ratio

  15. Break-even point in units sold SAR 80,000 SAR 200 = SAR 80,000 40% Break-even point in total sales = Calculating the BEP in WindNote: Using the information from Wind Bicycle company in previous examples 400 bikes = Can multiply 400 x SAR500 to get b/e in sales = SAR200,000 Or… Which one do you use? Whichever one you like, often it depends on what information you have

  16. Target Profit Analysis • How many units do I need to sell in order to make a given profit • … a slight amendment to your break- even formulas

  17. Sales required to achieve a target profit Equation method Units = Fixed Costs + Target profit Contribution per unit CM Margin Method Sales = Fixed Costs + Target profit CM Ratio

  18. Units required to achieve target profit SAR 80,000 + SAR100,000 SAR 200 = SAR 80,000 + SAR100,000 40% Sales value required to achieve target profit = Analysing Target Profit in Wind Suppose Wind Bicycle Co. wants to know how many bikes it must sell in order to earn a profit of SAR100,000 = 900 bikes = SAR450,000

  19. Margin of Safety • The extent to which planned volume of output or sales lies above the BEP (in value or units) 1. Margin of Safety in monetary value = Expected sales – Breakeven sales 2. Margin of Safety in units = Margin of Safety in monetary value/SP per unit 3. Percentage margin of safety = Expected sales – Breakeven sales Expected sales

  20. Example: Margin of Safety for Wind Bicycle Company • Percentage margin of safety Formula: Expected sales – Breakeven sales Expected sales SAR250,000 – SAR200,000 = SAR250,000 20% • Margin of Safety in Sales or Units Formula for Sales: Expected sales – Breakeven sales SAR250,000 – SAR200,000 = SAR50,000 (sales revenue can reduce by up to SAR50,000 before loss is made) Formula for Units: Margin of Safety (sales)/SP per unit 50,000/500 = 100 units

  21. CVP Relationships in graphical form Viewing CVP relationships in a graph gives managers a perspective that can be obtained in no other way. Consider the following information for Wind Bicycle Co.: Total cost 170K Total cost 200K Total cost 230K

  22. CVP graph Wind Bicycles Total expenses Pounds (SAR) Fixed expenses Units

  23. CVP graph Wind Bicycles Total sales Pounds (SAR) Units

  24. CVP graph Wind Bicycles Profit area Pounds (SAR) Break-even point Loss area Units

  25. Assumptions of CVP Analysis • Selling price is constant throughout the entire relevant range • Costs are linear throughout the entire relevant range • In multi-product companies, the sales mix is constant • In manufacturing companies, stocks do not change (units produced = units sold)

  26. The concept of sales mix • Sales mix is the relative proportions in which a company’s products are sold • Different products have different selling prices, cost structures, and contribution margins • Let’s assume Wind sells bikes and carts and see how we deal with break-even analysis

  27. Sales mix in Wind Co Wind Bicycle Co. provides us with the following information: SAR265,000 SAR550,000 = 48% (rounded) Breakeven= SAR170,000 0.48 = SAR354,167 (rounded) Broken down into……. Bikes 160,985 (354,167 x 250/550) Carts 193,181 (354,167 x 300/550)

  28. Remember Mixed Costs? Costs SAR Variable element Fixed element Output

  29. Mixed costs Mixed costs can be broken down into their fixed and variable components using the high-low method

  30. High - Low method ID period with lowest level of activity and period with highest level of activity, observe the difference in cost and divide by the change of activity

  31. Steps • Step 1: Calculate the difference between the highest and lowest units/activity and costs • Step 2: Calculate the variable costs per unit • Step 3: Calculate the total variable costs • Step 4: Calculate fixed costs Total costs – variable costs = fixed costs

  32. E.g. Riyadh Hospital Estimate fixed and variable elements of maintenance costs?

  33. High-Low method in Riyadh Hospital Step 1 Activity Cost High level activity 8,000 SAR9,800 Low level activity 5,000 SAR7,400 Difference 3,000 SAR2,400 Step 2: Calculate variable cost per unit Variable cost = SAR2,400 / 3,000 units = SAR0.80 Step 3: Calculate total variable cost Choose either high or low activity, we will choose high 8,000 units * 0.80 = 6,400 Step 4: Calculate total fixed costs Fixed cost = SAR9,800 – SAR6,400 = SAR3,400

  34. E.g. WiseCo Ltd The following activity levels have been recorded for the past six periods for one of WiseCo’s mixed costs: Requirements : Separate fixed and variable cost elements of the mixed cost, using the high-low method.

  35. High-Low method in Wise Company Step 1 Activity Cost High level activity 42,000 SAR199,200 Low level activity 33,000 SAR161,400 Difference 9,000 SAR37,800 Step 2: Calculate variable cost per unit Variable cost = SAR37,800 / 9,000 units = SAR 4.20 Step 3: Calculate total variable cost Choose either high or low activity, we will choose high 42,000 units * 4.20 = SAR 176,400 Step 4: Calculate total fixed costs Fixed cost = SAR199,200 – SAR176,400 =SAR22,800

  36. High - Low method • Advantages • Very simple to apply • Disadvantages • Suffers from a major defect- utilizes only 2 data points, generally not enough to produce accurate results in cost analysis work • There are more sophisticated mathematical approaches to the separation of mixed costs, but high-low applies the underlying assumption of CVP

  37. The high-low method If sales salaries and commissions are SAR10,000 when 80,000 units are sold and SAR14,000 when 120,000 units are sold, what is the variable portion of sales salaries and commission? a. SAR0.08 per unit b. SAR0.10 per unit c. SAR0.12 per unit d. SAR0.125 per unit

  38. SAR4,000 ÷ 40,000 units = SAR0.10 per unit The high-low method If sales salaries and commissions are SAR10,000 when 80,000 units are sold and SAR14,000 when 120,000 units are sold, what is the variableportion of sales salaries and commission? a. SAR0.08 per unit b. SAR0.10 per unit c. SAR0.12 per unit d. SAR0.125 per unit

  39. The high-low method If sales salaries and commissions are SAR10,000 when 80,000 units are sold and SAR14,000 when 120,000 units are sold, what is thefixedportion of sales salaries and commissions? a. SAR 2,000 b. SAR 4,000 c. SAR10,000 d. SAR12,000

  40. The high-low method If sales salaries and commissions are SAR10,000 when 80,000 units are sold and SAR14,000 when 120,000 units are sold, what is the fixed portion of sales salaries and commissions? a. SAR 2,000 b. SAR 4,000 c. SAR10,000 d. SAR12,000

More Related