Chapter 6 Cost-Volume-Profit Relationships

# Chapter 6 Cost-Volume-Profit Relationships - Chapter 6...

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Chapter 6 – Cost-Volume-Profit Relationships Cost-volume-profit (CVP) analysis is a powerful too that helps managers understand the relationship among cost, volume and profit. The Basics of Cost-Volume-Profit (CVP) Analysis The contribution income statement is helpful to managers in judging the impact on profits of changes in selling price, cost, or volume. For example, let's look at a hypothetical contribution income statement for Racing Bicycle Company (RBC). Notice the emphasis on cost behavior. Variable costs are separate from fixed costs. The contribution margin is defined as the amount remaining from sales revenue after variable expenses have been deducted. Contribution margin is used first to cover fixed expenses. Any remaining contribution margin contributes to net operating income. Sales, variable expenses, and contribution margin can also be expressed on a per unit basis. For each additional unit Racing Bicycle Company sells, \$200 more in contribution margin will help to cover fixed expenses and provide a profit. Each month Racing Bicycle must generate at least \$80,000 in total contribution margin to break-even (which is the level of sales at which profit is zero). If Racing sells 400 units a month, it will be operating at the break-even point. Total sales will be 400 units times \$500 each or \$200,000, and total variable expenses will be 400 units times \$300 each for \$120,000. Contribution margin is exactly equal to total fixed expenses. Let’s see what happens if Racing sells one more bike or a total of 401 bikes. You can see that the sale of one unit above the break-even point yields net operating income of \$200, which is the contribution margin per unit sold. If we develop equations to calculate break-even and net income, we will not have to prepare an income statement to determine what net income will be at any level of sales. For example, we know that if Racing Bicycle sells 430 units, net operating income will be \$6,000. The company will

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## This note was uploaded on 10/25/2010 for the course MGT 11B taught by Professor Hancock during the Spring '07 term at UC Davis.

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Chapter 6 Cost-Volume-Profit Relationships - Chapter 6...

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