0 CHAPTER 7 Cost-Volume-Profit Analysis © 2009 Cengage Learning.

1

CHAPTER 7

Cost-Volume-Profit Analysis

© 2009 Cengage Learning

2

2

Introduction

Cost-volume-profit (CVP) analysis focuses on the following factors:

1. The prices of products or services

2. The volume of products or services produced and sold

3. The per-unit variable costs

4. The total fixed costs

5. The mix of products or services produced

3

3

The Contribution Margin Income Statement

The contribution margin income statement is

structured by behavior rather than by function.

Sales - All Variable Costs = Contribution Margin

Contribution Margin - All Fixed Costs = Net Income

4

4

Income Statements

TRADITIONAL CONTRIBUTION MARGIN

Sales Less:

Cost of Goods Sold:

Variable CostsFixed Costs

Total Cost of Goods SoldGross ProfitLess: S, G, & A Costs:

Variable CostsFixed Costs

Total S, G, & A CostsNet Income

SalesLess: Variable Costs:

Manuf. CostsS, G, & A Costs

Total Variable CostsContribution MarginLess: Fixed Costs:

Manuf. CostsS, G, & A Costs

Total Fixed CostsNet Income

$1,000

350150

$ 500

$ 500

$ 50250

$ 300

$ 200

$1,000

$35050

$400$600

$150250

$400$200

5

5

The Contribution Margin Income Statement

The contribution margin income statement is

structured to emphasize cost behavior as opposed to cost

function.

Key Concept

6

6

Contribution Margin Per Unit

Sales (100,000 units) Less: Variable Costs Contribution MarginLess: Fixed CostsNet Income

Total

$200,00080,000

$120,00040,000

$80,000

Per Unit

$2.00.80

$1.20

7

7



Total

$200,002.0080,000.80

$120,001.2040,000.00

$80,001.20

Per Unit

$2.00.80

$1.20

What if Cheri’s Chips sold one more unit?

8

8


For every unit change in sales, contribution

margin will increase or decrease by the

contribution margin per unit multiplied by the

increase or decrease in sales volume.

Key Concept

9

9

Contribution Margin Ratio


Is equal to

Contribution Margin (in $)

Sales (in $)

10

10



Total

$200,00080,000

$120,00040,000

$80,000

Percent

100%40 60%

$120,000$200,000

11

11


The contribution margin per unit and the contribution margin ratio will remain constant as long as sales vary in direct proportion with volume.

Key Concept

12

12


For every dollar change in sales, contribution margin will increase or decrease by the contribution margin ratio multiplied by the increase or decrease in sales dollars.

Key Concept

13

13

The Contribution Margin and Its Uses

What would happen if sales increase?

Use the CM to determine the increase in net income. Then consider options to increase sales.

Lower sales price?

Increase incentives for sales staff?

Improve quality of product?

Increase advertising budget?

14

14

Decisions Using CVP

Option 1: Reduce variable costs.

When variable costs are reduced, contribution margin will increase. Options?

•Find less expensive supplier of raw material

•Reduce the amount of labor used

•Use lower-wage employees

What would be the consequences of each?

15

15

Decisions Using CVP

SalesLess: Variable Costs Contribution MarginLess: Fixed CostsNet Income (Loss)

Current

$200,00080,000

$120,00040,000

$80,000

Option 1

$200,00072,800

$127,20040,000

$87,200

Lower Variable Costs by $7,200

16

16

Decisions Using CVP

Option 2: Change incentive structure

Raise sales commissions on all sales above the present level by 10 percent. Sales will increase by $30,000 or 15,000 bags. Additional sales commission will be $3,000.

17

17

Decisions Using CVP

Impact of increasing Sales Incentives, Sales = $230,000


Total$200,000

80,000$120,000

40,000$80,000

Option 2$230,000

95,000$135,000

40,000$95,000

Variable Costs: 230,000*.40% + $3,000

18

18

Decisions Using CVP

Option 3: Increase Advertising

Spending an additional $10,000 on advertising will increase sales by $40,000 or 20,000 bags.

19

19

Decisions Using CVP

Impact of increasing advertising: Sales = $140,000


Current

$200,000 80,000$ 120,000 40,000$ 80,000

Option 3

$240,000 96,000$ 144,000 50,000$ 94,000

20

20

Changes in Price and Volume

If the manager changes the sales price resulting in a change in sales volume, what will be the impact on

net income?

Raising the sales price may decrease sales volume but the

impact on total sales revenue may be offset by the increase in sales

price.

Decreasing the sales price may increase the sales volume without

increasing total sales revenue.

21

21

Changes in Price and Volume

These business decisions involve individuals in many areas of an

organization, such as marketing, sales, production management,

and even human resources personnel for hiring decisions. The

implications of a bad decision in this area can affect the firm’s

bottom line.

22

22

Changes in Cost, Price, and Volume

Changes can be made to cost, price, and volume at the same

time.

Changes in one variable almost always impact one or both of the other variables.

23

23

Break-Even Analysis

Break-Even Point: The level of sales where contribution margin just covers fixed costs and consequently net income is equal to zero.

24

24

Break-Even Analysis

Fixed Costs Contribution Margin Per Unit

Break-Even (Sales $)

Break-Even

(units)

=

Fixed CostsContribution Margin Ratio=

25

25

Break-Even Graph

Volume

$Revenue

Total Cost

Break-Even Point

Break-Even Point in VolumeBreak-EvenPointin $

Loss Area

Profit Area

26

26

Break-Even Calculations with Multiple Products

The calculation of “average” contribution margin is really a weighted average.

Break-Even (Units) =

Fixed Costs

Weighted Average Contribution Margin

Per Unit

27

27

Break-Even Calculations Using Activity-Based

Costing

When using activity-based-costing, costs are classified as unit, batch, product, or facility

level instead of variable or fixed.

Break-Even (units) =Fixed Costs + Batch-Level Costs +

Product-Level Costs


28

28

Target Profit Analysis(Before and After Tax)

To determine the sales units required to achieve a target

profit before taxes:

Sales Volume =

Fixed Costs + Target Profit (before taxes)


29

29


Multiple product formula to reach a target profit:

Sales Volume =

Fixed Costs + Target Profit

Weighted-Average Contribution Margin Per Unit

30

30


ABC formula to reach a target profit:

Sales (units) =

Fixed Costs + Batch-Level Costs + Product-Level Costs + Target Profit

Weighted-Average Contribution Margin Per Unit

31

31

The Impact of Taxes

If

After-Tax Profit = Before-Tax Profit (1-tax rate)

then

Before-Tax Profit = After-Tax Profit / (1-tax rate)

Therefore, to determine after-tax Target Profit

Sales in units =

Fixed Costs + After-Tax Profit / (1-Tax Rate)

Contribution Margin per Unit

32

32

The Impact of Taxes

The payment of income tax is an

important variable in target profit and other

CVP decisions.

Key Concept

33

33

Assumptions of CVP Analysis

1. Selling price is constant throughout the relevant range.

2. Costs are linear throughout the relevant range.

3. The sales mix used to calculate the weighted average contribution margin is constant.

4. The amount of inventory is constant.

34

34

Cost Structure and Operating Leverage

Operating Leverage: The measure of the proportion of

fixed costs in a company’s cost structure. It is used as an indicator of how sensitive

profit is to changes in sales volume.

35

35


Operating Leverage =

Contribution Margin

Net Income

Operating Leverage X % Increase in Sales = % Increase in Net Income

36

36


Company B 500 1,000 2,000

Sales

Cont. Margin

Net Income

$100,000

$ 60,000

$ 20,000

$200,000

$120,000

$ 80,000

$400,000

$240,000

$200,000

Operating Leverage

$60,000

$20,000

$120,000

$80,000

$240,000

$200,000

3.0 1.5 1.2

10% Increase in Sales30% 15% 12%

37

37


A company operating near the break-even point will have a high

level of operating leverage and income will

be very sensitive to changes in sales volume.

Key Concept

0 CHAPTER 7 Cost-Volume-Profit Analysis © 2009 Cengage Learning.

Documents

unit variable costs

costs net income sales

costs s

costs total s

unit sales

sales increase

fixed costs net income

net income slide