A MANAGERIAL PLANNING TOOL
CVP analysis allows managers to focus on
selling prices, volume, costs, profits, and
sales mix. Many different “what-if” questions
can be asked to assess the effect on profits
of changes in key variables.
The units sold approach defines sales
volume in terms of units of product and
gives answers in these same terms. The unit
contribution margin is needed to solve for
the break-even units. The sales revenue ap-
proach defines sales volume in terms of rev-
enues and provides answers in these same
terms. The overall contribution margin ratio
can be used to solve for the break-even
is the level of sales activity
where total revenues equal total costs, or
where zero profits are earned.
At the break-even point, all fixed costs are
covered. Above the break-even point, only
variable costs need to be covered. Thus,
contribution margin per unit is profit per unit,
provided that the unit selling price is greater
than the unit variable cost (which it must be
for break-even to be achieved).
Variable cost ratio = Variable costs/Sales
Contribution margin ratio
= Contribution margin/Sales
Contribution margin ratio
= 1 – Variable cost ratio
No. The increase in contribution is $9,000
$30,000), and the increase in advert-
ising is $10,000. If the contribution margin ra-
tio is 0.40, then the increased contribution
margin is $12,000 (0.4
$30,000). This is
$2,000 above the increased advertising ex-
pense, so the increased advertising would be
a good decision.
is the relative proportion sold of
each product. For example, a sales mix of
3:2 means that three units of one product
are sold for every two of the second product.
Packages of products, based on the expec-
ted sales mix, are defined as a single
product. Selling price and cost information
for this package can then be used to carry
out CVP analysis.
This statement is wrong; break-even analys-
is can be easily adjusted to focus on tar-
The basic break-even equation is adjusted
for targeted profit by adding the desired tar-
geted profit to the total fixed costs in the nu-
merator. The denominator remains the con-
tribution margin per unit.
A change in sales mix will change the contri-
bution margin of the package (defined by the
sales mix) and, thus, will change the units
needed to break even.
Margin of safety
is the sales activity in excess
of that needed to break even. The higher the
margin of safety, the lower the risk.
is the use of fixed costs
to extract higher percentage changes in
profits as sales activity changes. It is
achieved by increasing fixed costs while
lowering variable costs. Therefore, increased
leverage implies increased risk, and vice