03
Chapter CHAPTER Outline
Cost-Volume-Profit (CVP) Analysis
What is CVP analysis?
Breakeven Point
What?
How?
Contribution margin
Equation
Graph
Applications
Target profit
Margin of Safety
Changes and sensitivity Analysis
Cost-Volume-Profit Analysis (CVP)
What is cost-volume-profit analysis?
It is the study of the effects of output
volume on revenue (sales), expenses
(costs), and net income (net profit).
Cost-Volume-Profit Analysis
(CVP)
Contribution Income Statement
Sales
Less: variable expenses
Contribution margin
Less: fixed expenses
Net income
The Break-Even Point
The break-even point is the volume of activity
where the organizations revenues and
expenses are equal.
Sales
Less: variable expenses
Contribution margin
Less: fixed expenses
Net income
NI = 0
$250,000
150,000
100,000
100,000
$
-
2 Relations?
The Break-Even Point
The break-even point is the volume of activity
where the organizations revenues and
expenses are equal.
Sales
Less: variable expenses
Contribution margin
Less: fixed expenses
Net income
$250,000
150,000
100,000
100,000
$
-
NI = 0
The Break-Even Point
The break-even point is the volume of activity
where the organizations revenues and
expenses are equal.
Sales
Less: variable expenses
Contribution margin
Less: fixed expenses
Net income
$250,000
150,000
100,000
100,000
$
-
NI = 0
Break-Even Point
Techniques
The break-even point is the point where
total revenue equals total costs (both
variable and fixed).
Unit CM
Contribution margin
CM Ratio
Equation
Contribution Margin Method
Break-even
Fixed costs
=
volume in units
Contribution margin per unit
BEP (dollars) = BEP (units) x Selling Price
Contribution Margin Method
Break-even
in dollars
=
Fixed costs
Contribution margin ratio
BEP (units) = BEP (dollars) / Selling Price
Contribution Margin Method
Break-even
Fixed costs
=
volume in units
Contribution margin per unit
Break-even
in dollars
=
Fixed costs
Contribution margin ratio
BEP (units) = BEP (dollars) / Selling Price
BEP (dollars) = BEP (units) x Selling Price
Example
Bright Day is considering the introduction of a new
product called Multi Minerals. The companys first
concern is whether it can sell at least enough units to
cover its fixed costs! Here is some per unit information
about Multi Minerals:
Sales revenue per unit
Variable cost per unit
Contribution margin per unit
$ 20
12
100%
60%
Bright Day expects to incur $24,000 in fixed marketing
costs in connection with Multi Minerals.
Lets calculate the break-even point in units and
dollars.
Example
Break-even in Units
Break-even in Dollars
Fixed costs
CM per unit
Fixed costs
CM ratio
=
units
Lets Proof it!!!
=$
Example
Here is the proof
Units
$
Total
Sales revenue
3,000 $ 20
Variable cost
3,000
Contribution margin
3,000 $
12
8
Fixed Cost
Net Income
0
BEP
NI = 0?
Check Yourself
Matrix, Inc. manufactures one model of lawnmower the
sells for $175 each. Variable expenses to produce the
lawnmower are $100 per unit. Total fixed costs are
$225,000 per month. Use the contribution method to
determine how many lawnmowers Matrix must sell
next month:
1. 3,000.
2. 3,500.
3. 4,000.
4. 4,500.
Check Yourself
Matrix, Inc. manufactures one model of lawnmower the
sells for $175 each. Variable expenses to produce the
lawnmower are $100 per unit. Total fixed costs are
$225,000 per month. Use the contribution method to
determine how much in sales revenue must
lawnmowers Matrix make the next month:
1. $525,000.
2. $600,500.
3. $754,000.
4. $487,500.
The Equation Method
The equation method begins by expressing the income statement
At the break-even point, profit = zero
At the break-even point:
Sales Revenue = Total Cost
Sales Revenue = Variable cost + Fixed cost
We can look at the above equation like this:
Selling price per unit
Number of units sold
=
Variable cost per unit
Number of units sold
+
Fixed cost
Check Yourself
Matrix, Inc. manufactures one model of lawnmower the
sells for $175 each. Variable expenses to produce the
lawnmower are $100 per unit. Total fixed costs are
$225,000 per month. Use the equation method to
determine how many lawnmowers Matrix must sell
next month:
1. 3,000.
2. 3,500.
3. 4,000.
4. 4,500.
Cost-Volume-Profit Graph
We have developed income statements for zero sales,
break-even sales, and ten thousand units.
Units sold
Revenue @ $36
Variable Expenses @ $24
Contribution Margin @$12
Fixed Expenses
Net Income
Income
$
(60,000)
$ (60,000)
at Various Levels
5,000
10,000
$ 180,000
$ 360,000
(120,000)
(240,000)
60,000
120,000
(60,000)
(60,000)
$
$ 60,000
Information to prepare a break-even Excel graph.
Units sold
Revenue
Total Cost
Fixed Cost
60,000
60,000
5,000
180,000
180,000
60,000
10,000
360,000
300,000
60,000
Cost-Volume-Profit Graph
Draw and label the axes.
Horizontal axis activity (in units)
Vertical axis - dollars
Draw the sales line.
A diagonal line that begins at the origin
Draw the fixed cost line.
A horizontal line
Draw the total cost line.
A diagonal line that begins at the fixed cost line and vertical
axis
Cost-Volume-Profit Graph
Break-even Graph
Dollars
400,000
300,000
Revenue
BEP
Total Cost
$180,000
200,000
Fixed Cost
5,000 units
100,000
-
5,000
10,000
Units Sold
Loss Area
Profit Area
Applications of CVP:
1. Target Net Profit
Managers can also use
CVP analysis to determine
the total sales, in units
and dollars, needed to
reach a target net profit.
At the break-even point:
Applications of CVP:
1. Target Net Profit
Break-even
Fixed costs
=
olume in units Contribution margin
per unit
Sales Revenue = Total Cost
Sales Revenue = Variable cost +
Fixed cost
Contribution Margin Technique
Equation Technique
Target sales volume in units =
Fixed expenses + Target net income
Contribution margin per unit
Target sales=
Variable expenses
+ Fixed expenses
+ Target net income
Target sales revenue in $ =
Fixed expenses + Target net income
Contribution margin ratio
Example: Target Profit
Bright Days president want the advertising campaign to
produce profits of $40,000 to the company. The sales
revenue per unit is $36, the unit variable cost is $24 and
the total fixed cost is $60,000
Fixed costs
Break-even
=
volume in units Contribution margin per unit
$60,000
$12
=
Break-even in $
=
= 5,000 units
Fixed costs
Contribution margin ratio
=
$60,000
33.33%
=$180,000
Example: Target Profit
Bright Days president want the advertising campaign to
produce profits of $40,000 to the company. The sales
revenue per unit is $36, the unit variable cost is $24 and
the total fixed cost is $60,000
Target
= Fixed costs + Desired profit
volume in units Contribution margin per unit
Target Sales in $ = Fixed costs + Desired profit
Contribution margin ratio
Proof???
Example
Here is the proof
Sales revenue
Variable cost
Contribution margin
Fixed Cost
Net Income
Target Profit
Check Yourself
Matrix, Inc. manufactures one model of lawnmower the
sells for $175 each. Variable expenses to produce the
lawnmower are $100 per unit. Total fixed costs are
$225,000 per month, and management wants to
earn a profit in the coming month of $37,500. Use
the contribution method to determine how many
lawnmowers Matrix must sell next month:
1. 3,000.
2. 3,500.
3. 4,000.
4. 4,500.
Applications of CVP:
2. Margin of Safety
The margin of safety shows far
sales how can fall below the planned level
before losses occur.
=
Planned sales
Break-even sales
Margin of safety
Units
Dollars
Percentage
Applications of CVP:
2. Margin of Safety
Budgeted sales
Break-even sales
Margin of safety
Margin of
=
Safety %
Margin of
Safety %
In Units
4,375
(1,875)
In Dollars
$ 122,500
(52,500)
Budgeted sales Break-even sales
Budgeted sales
=
=
Margin of Safety
Operating Leverage
Risk Preference
%
Applications of CVP:
3. Sensitivity Analysis
Multiple Changes in Key Factors
Changes in Prices
Changes in Variable Cost
Changes in Fixed Cost
CVP is used as a tool to answer
what if questions
Assessing the Pricing Strategy
Cost-Plus
Pricing
Price products at variable cost
plus some percentage of the
variable, normally 50%.
Prestige
Pricing
Price products with a premium
because the product is new or
has a prestigious name brand.
Target
Pricing
Price products at the market
price and then control costs to
be profitable at the market
price.
3-31
Assessing the Pricing Strategy
The Marketing Department at Bright Day suggests
that a price drop from $36 per bottle to $28 per bottle
will make Delatine a more attractive product to sell.
The president wants to know what such a price drop
would have on the companys stated goal of
producing a $40,000 profit.
You have been asked to determine the number of
bottles that must be sold to earn the $40,000 profit at
the new $28 selling price per bottle. See if you can
provide an answer to the president before going to
the next screen!
Target profits = $40,000
Unit SP = $36 $28
Unit VC = $24
Total FC = $60,000
Effects of Changes in Sales Price
Step 1
New Selling Price Per Bottle $ 28
Variable Expenses Per Bottle
24
New Contribution Margin
$4
Step 2
Target
Fixed costs + Desired profit
=
Volume in units Contribution margin per unit
Step3
=
Proof
Changes in Variable Costs
Bright Day is considering an alternative mixture for
Delatine along with new packaging. This new
product would sell for $28 per bottle and have a
variable cost per bottle of $12. The president is not
in favor of the new product but wants to know how
many units must be sold to produce the desired
profit of $40,000.
You have been asked to determine the units that
must be sold and the total sales revenue that will
be produced!
Target profits = $40,000
Unit SP = $28
Unit VC = $24 $12
Total FC = $60,000
Changes in Variable Costs
Step 1
New Selling Price Per Bottle $ 28
Variable Expenses Per Bottle
12
New Contribution Margin
$ 16
Step 2
Target
Fixed costs + Desired profit
=
volume in units Contribution margin per unit
Step3
=
Target profits = $40,000
Unit SP = $28
Unit VC = $12
Total FC = $60,000$30,000
Bright Days president has asked you to determine the
required sales volume if advertising costs were reduced
to $30,000, from the planned level of $60,000.
Changes in Fixed Costs
Target
$30,000 + $40,000
=
volume (units)
$16
Units sold
Revenue @ $28
Variable Expenses @ $12
Contribution Margin @$16
Fixed Expenses
Net Income
= 4,375 units
Income
4,375
$ 122,500
(52,500)
70,000
(30,000)
$ 40,000
Target profits = $40,000
Unit SP = $28$25
Unit VC = $12
Total FC = $30,000
Decrease in Sales Price with an
Increase in Sales Volume
The marketing manager believes reducing the sales price
per bottle to $25 will increase sales volume by 625 units.
Previous sales volume was:
Target
$30,000 + $40,000
=
volume (units)
$16
= 4,375 units
Anticipated changes:
In Dollars
New selling price
Variable costs per unit
Contribution margin
$ 25
(12)
$ 13
Previous units sold
Additional units sold
Expected sales volume
Accept or Reject Proposal?
In
4,375
625
5,000
Target profits = $40,000
Unit SP = $28$25
Unit VC = $12
Total FC = $30,000
Decrease in Sales Price with an
Increase in Sales Volume
Current Situation
Income
Units sold
Revenue @ $28
Variable Expenses @ $12
Contribution Margin @$16
Fixed Expenses
Net Income
Because budgeted
income will ?,
the proposal should
be ?
Proposed Situation
Income
Units sold
Revenue @ $25
Variable Expenses @ $12
Contribution Margin @$13
Fixed Expenses
Net Income
Target profits = $40,000
Unit SP = $28
Unit VC = $12
Total FC = $30,000$42,000
Increased in Fixed Costs and
Increase in Sales Volume
After the previous project was rejected, the advertising manager
believes that buying an additional $12,000 in advertising can
increase sales volume to 6,000 units. The contribution margin will
remain at $16. Should the company buy the additional advertising?
Profit = Contribution margin Fixed cost
Profit =
Proposed Situation
Current Situation
Units sold
Revenue @ $28
Variable Expenses @ $12
Contribution Margin @$16
Fixed Expenses
Net Income
Income
4,375
Units sold
Revenue @ $28
Variable Expenses @ $12
Contribution Margin @$16
Fixed Expenses
Net Income
Income
6,000
Target profits = $40,000
Unit SP = $28$25
Unit VC = $12$8
Total FC = $30,000$22,000
Change in Several Variables
Management has been able to reduce variable costs
to $8 per bottle and decides to reduce the selling
price per bottle to $25 (so the contribution margin is
now $17). Further, management believes that if
advertising is cut to $22,000, the company can still
expect sales volume to be 4,200 units.
Should management adopt this plan?
Target profits = $40,000
Unit SP = $28$25
Unit VC = $12$8
Total FC = $30,000$22,000
Change in Several Variables
Profit = Contribution margin Fixed cost
Profit =
Proposed Situation
Current Situation
Units sold
Revenue @ $28
Variable Expenses @ $12
Contribution Margin @$16
Fixed Expenses
Net Income
Income
4,375
Units sold
Revenue @ $25
Variable Expenses @ $8
Contribution Margin @$17
Fixed Expenses
Net Income
Income
4,200
Applications of CVP:
3.Sensitivity Analysis
CVP Analysis and ComputerBased Spreadsheets
Exhibit 3.3
The use of spreadsheets simplifies
the examination of multiple changes
in key factors in a CVP model.
Use of these models is a cost-benefit issue.
Performing Sensitivity Analysis Using
Spreadsheet Software
After reviewing the spreadsheet analysis, Bright Days
management team is convinced it should undertake radio
advertising for Delatine.
Management considers a new product, Delatine
that has a sales price of $36 and variable costs
of $24 per bottle. Fixed costs are $60,000. Breakeven is 5,000 units.
Target costing is employed to reengineer the
product and reduces variable cost per unit to
$12. To earn the desired profit of $40,000, sales
volume decreases to 6,250 units.
Management wants to earn a $40,000 profit on
Delatine. The sales volume to achieve this
profit level is 8,334 bottles sold.
Target costing is applied and fixed costs are
reduced to $30,000. The sales volume to earn
the desired $40,000 profit is 4,375 units.
Marketing advocates a target price of $28 per
bottle. The sales volume required to earn a
$40,000 profit increases to 25,000 bottles.
In view of the 57.14% margin of safety,
management decides to add Delatine to its
product line.
Cost-Volume-Profit Limitations
CVP is limited by a number of underlying assumptions.
1
The selling price is constant.
2
Costs are linear.
3
The multiproduct sales mix is constant.
4
Inventory levels in manufacturing companies are
constant.
5
All CVP variables are within the relevant range.
3-45
We made
it!
Perform multiple-product breakeven analysis.