Chapter7StudentFall2018.docx - Chapter 7 \u2013 Cost-Volume-Profit Analysis 7.1 Cost-Volume-Profit Analysis(CVP \u2022 Powerful tool that helps managers make

Chapter7StudentFall2018.docx - Chapter 7 –...

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Chapter 7 – Cost-Volume-Profit Analysis 7.1 Cost-Volume-Profit Analysis (CVP) Powerful tool that helps managers make important business decisions Relies on the interdependency of five components of information 1) Sales price per units 2) Volume sold 3) VE per unit 4) Fixed Expenses 5) Operating Income (profit or loss) If you know or can estimate four of these five components, you can compute the remaining unknown amount Assumptions Underlying CVP Analysis Managers must be aware of these when using CVP: 1. Change in volume is only factor that affects costs 2. Managers can classify each cost as either variable or fixed. These costs are linear throughout relevant range 3. Revenues are linear throughout relevant range 4. Inventory levels will NOT change 5. The sales mix of products will NOT change Combination of products that make up total sales Contribution Format Income Statement and Contribution Margin Per Unit Contribution Margin per Unit = Selling Price per unit – VE per unit Or = Total Contribution Margin / # of units Total Sales Total Variable Expenses
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Once a company’s contribution margin covers its fixed costs, each additional unit sold increases profit by the amount of the unit contribution margin Now assume sales are 2,500 units. What would operating income be? Contribution Margin $50,000 Less Fixed Costs 30,000 Operating Income $20,000 Or Original Operating Income + ( Additional units x CM per unit) $10,000=(500 x $20 CM) = $20,000 Contribution Margin Ratio (CMR) Percentage of each sales dollar that is available for covering fixed expenses and generating a profit CMR is particularly useful when unit information is not available or a company has multiple products. Contribution Margin Ratio = Total CM / Total Sales Or = CM per unit / SP per unit Using the information from our previous examples, contribution margin and variable expenses can also be expressed as a percent of sales: How many units did the company sell? $100,000/$50=2000 What would operating income be if the company sold one more unit? $10,020(add $20 for sell one more unit) more unit at $50 per unit? Contribution margin per unit is the selling price of one unit minus the variable cost per unit If sales increase $1,000, how much will operating income increase? $1,000 x 40% = $400 $40,000 or $20 $100,000 $50
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Notice that the Contribution Margin Ratio and the Variable Expense Ratio must = 100%. Consequently, if you know the one of the ratios, you automatically know the other. If sales are $125,000, what would operating income be? Contribution Margin 125,000 x 40% $50,000 Less Fixed Costs 30,000 Operating Income $20,000 Mom and Pop's Ice Cream Shoppe sells ice cream cones for $5.00 per customer. Variable costs are $2.25 per cone. Fixed costs are $3,000 per month. What is the company's contribution margin per ice cream cone? $5.00 - $2.25 = $ 2,75 What is the company's contribution margin ratio? $2.75/$5.00 = 55% Determine operating income if the company sells 3,000 cones in a month.
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