Module 15 - Module 15 Cost­Volume­Profit Analysis and...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Module 15 Cost­Volume­Profit Analysis and Planning ©Cambridge Business Publishers, 2009 Involves examining the relationships among revenues, costs, and profits Widely used in the economic evaluation of existing or proposed products or services Performed before decisions are finalized What you need to understand to perform profitability analysis • Selling prices • behavior of activity cost drivers Profitability Analysis ©Cambridge Business Publishers, 2009 Cost­Volume­Profit Analysis A technique to examine the relationships among total volume of an independent variable, total costs, total revenues, and profits for a time period Useful in the early stages of planning Provides an easily understood framework for discussing planning issues and organizing relevant data ©Cambridge Business Publishers, 2009 CVP Use in For­Profit Companies Provides answers to questions such as… How many cappuccinos must Starbucks sell to earn total profit of $50,000? At what sales volume will McDonald’s total revenues and total costs be equal? What profit will Office Max earn at sales volume of $200 million? What will happen to Disney’s profit if ticket selling prices are increased by 10% and fixed costs increase by 8%? ©Cambridge Business Publishers, 2009 CVP Use in Not­For­Profit Companies Used by not­for­profit entities to…… Establish service levels Plan fund­raising events Determine funding requirements Answers questions such as…. How many homeless people can the Homeless Center house with a budget of $400,000? How much money must be raised from alumni at Princeton to provide 50 full scholarships? ©Cambridge Business Publishers, 2009 CVP Assumptions 1. All costs are classified as fixed or variable. 2. The total cost function is linear within the relevant range. 3. The total revenue function is linear within the relevant range. 4. The analysis is for a single product, or the sales mix of multiple products is constant. 5. There is only one activity cost driver: unit or dollar sales volume. Accuracy decreases as the scope of operations being analyzed increases. ©Cambridge Business Publishers, 2009 Profit (π ) of a product, service or event = Total revenues (R) minus total costs (Y): Revenues (R) are a function of unit sales volume (X) and unit X) and unit selling price (p): Total costs for a time period (Y) are a function of fixed costs per period(a) and unit and unit variable costs (b): ©Cambridge Business Publishers, 2009 The Profit Formula π =R-Y R = pX Y = a + bX Expanded Profit Formula Used to predict profit at any specified activity level, represented by X. ©Cambridge Business Publishers, 2009 To use the profit formula Using the Profit Formula Direct materials The cost of the primary raw materials converted into finished goods Variable Costs Direct labor Wages earned by production employees converting raw materials into finished goods ©Cambridge Business Publishers, 2009 Nature of costs Separate all the company’s costs into variable and fixed components Variable and Fixed Components Variable Costs Fixed Costs Variable manufacturing overhead All other variable costs associated with converting raw materials into finished goods Variable selling and administrative costs All variable costs not directly associated with converting raw materials into finished goods Fixed manufacturing overhead All fixed costs associated with converting raw materials into finished goods Fixed selling and administrative costs All fixed costs not directly associated with converting raw materials into finished goods ©Cambridge Business Publishers, 2009 Example Using the Profit Equation Estimated costs are: Chillin’ Time produces and sells one product, ice cream bars, for $1.50 each. To ensure top quality, no inventories are maintained. Variable Costs Per Ice Cream Bar Fixed Costs Per Month Manufacturing costs: Manufacturing overhead $1,200 Direct materials $0.43 Selling and 580 administrative Direct labor 0.32 Total $1,780 Manufacturing 0.20 overhead $0.95 Chillin’ Time must sell Selling and 0.15 6,950 ice cream bars Profit Formula to earn $1,000 $administrative 1,000 = $1.50X – $1,780 – $1.10X each month to result in Total $1.10 ©Cambridge Business Publishers, 2009 X = 6,950 ice cream bars $1,000 profit. Income Statement Formats Costs are classified according to behavior Contribution margin Variable Fixed Costs are classified according to function Gross margin Manufacturing Selling and administrative Total revenues less cost of goods sold Represents the amount that goes toward covering other expenses and providing a profit Total revenues less total variable costs Represents the amount that goes toward covering fixed costs and providing a profit ©Cambridge Business Publishers, 2009 Contribution Income Statement Example Chillin’ Time Contribution Income Statement For a Monthly Volume of 6,950 Ice Cream Bars Sales (6,950 x $1.50) Less variable costs: Direct materials (6,950 x $0.43) Direct labor (6,950 x $0.32) Manufacturing overhead (6,950 x $0.20) Selling and administrative (6,950 x $0.15) Contribution margin Less fixed costs: Manufacturing Selling and administrative ©Cambridge Business Publishers, 2009 Profit $10,425. $2,988 2,224 1,390 1,043 (7,645) 2,780. 1,200 580 (1,780) $ 1,000. Functional Income Statement Example Chillin’ Time Functional Income Statement For a Monthly Volume of 6,950 Ice Cream Bars Sales (6,950 x $1.50) Less cost of goods sold: Direct materials (6,950 x $0.43) Direct labor (6,950 x $0.32) Variable manufacturing overhead (6,950 x $0.20) Fixed manufacturing overhead Gross margin Less other expenses: Variable selling and administrative (6,950 x $0.15) Fixed selling and administrative Profit ©Cambridge Business Publishers, 2009 $10,425. $2,988 2,224 1,390 1,200 (7,802) 2,623. 1,043 580 (1,623) $ 1,000. Sensitivity analysis Analysis Using Contribution Margin Ratio How a model responds to changes in one or more independent variables Indicates how sensitive an income model is to a change in unit sales The portion of every sales dollar contributed toward covering fixed costs and earning a profit Unit contribution margin Contribution margin ratio ©Cambridge Business Publishers, 2009 Contribution Margin Example Chillin’ Time’s contribution income appears below: Total Per Unit Sales (6,950 units) Variable costs Contribution margin Fixed costs Profit $ 10,425. (7,645) 2,780. (1,780) $ 1,000. $ 1.50. (1.10) Contribution margin per unit $1.50 – $1.10 = $0.40 Contribution margin ratio [$1.50 – $1.10] ÷ $1.50 = 0.2667 ©Cambridge Business Publishers, 2009 Example Example Sensitivity Analysis Total Per Unit Ratio to Sales If sales increase by 100 ice cream bars per month, by how much will net income increase? 100 × $0.40 = $40 If sales increase by $1,050 per month, by how much will net income increase? $1,050 × 0.2667= $280 ©Cambridge Business Publishers, 2009 Sales (6,950 units) Variable costs Contribution margin Fixed costs Profit $10,425. (7,645) 2,780. (1,780) $ 1,000. $ 1.50 (1.10) $ 0.40 1.000 (0.733) 0.267 Break­Even Point Occurs when total revenues equal total costs Operating below break­even Can be unit sales volume, or Dollar sales volume Operating above break­even Company operates at a loss Company operates at a profit ©Cambridge Business Publishers, 2009 Break­Even Point Fixed costs = Selling price per unit – Variable costs per unit Fixed costs = Contribution margin per unit Break­even unit sales volume ©Cambridge Business Publishers, 2009 Break­Even Point Example Chillin’ Time sells ice cream bars with a $1.10 unit variable cost for $1.50 each. How many bars must it sell to break even? = Fixed costs Contribution margin per unit $1,780 $1.50 – $1.10 = 4,450 units Chillin’ Time’s Break-Even Unit = Sales Volume When Chillin’ Time sells 4,450 ice cream bars per month, it will break even. ©Cambridge Business Publishers, 2009 Profit Planning – Target Profit Target unit sales volume = Fixed costs + Desired profit Contribution margin per unit If Chillin’ Time wants to earn a monthly profit of $800, how many ice cream bars must it sell? Chillin’ Time’s Target Unit = Sales Volume $1,780 + $800 $1.50 – $1.10 = 6,450 units When Chillin’ Time sells 6,450 ice cream bars per month, it will generate profit totaling $800. ©Cambridge Business Publishers, 2009 Cost­Volume­Profit Graph Total Revenues and Total Costs Break­even point 4,450 units Total costs line $1,780 + $1.10 per unit a are it Total revenue line $1.50 per unit $12,000 $10,000 $8,000 $6,000 $4,000 $0 ts d cos Fixe 80 $1,7 rof P Los $2,000 - a are s Variable costs line $1.10 per unit 8000 0 2000 4000 6000 Unit Sales ©Cambridge Business Publishers, 2009 Profit­Volume Graph Total profit Break­even point $6,675 $900 $600 $300 - Total Profit or (Loss) or loss line Profit area $4,000 $8,000 $12,000 $0 ($300) - Loss ($600) - area ($900) - Total Revenues ©Cambridge Business Publishers, 2009 Impact of Income Taxes Determining the unit sales volume required to earn a desired after­tax profit: Step 1. Determine the required before­tax profit. Step 2. Substitute the required before­tax profit into the profit formula. Step 3. Solve for the required unit sales volume. Before-tax profit = After-tax profit (1 – tax rate) ©Cambridge Business Publishers, 2009 Impact of Income Taxes Example Chillin’ Time sells ice cream bars with a $1.10 unit variable cost for $1.50 each. It is subject to a 30 percent income tax rate. How many ice cream bars must Chillin’ Time sell to earn a desired monthly after­tax profit of $840? Before-tax profit = After-tax profit (1 – tax rate) $840 = = $1,200 (1 – 0.30) Target unit = sales volume ©Cambridge Business Publishers, 2009 $1,780 + $1,200 $1.50 – $1.10 = 7,450 ice cream bars Contribution Income Statement With Income Taxes Sales (7,450 x $1.50) Less variable costs: Direct materials (7,450 x $0.43) Direct labor (7,450 x $0.32) Variable manufacturing overhead (7,450 x $0.20) Variable selling and administrative (7,450 x $0.15) $11,175 $3,204 2,384 1,490 1,118 Contribution margin Less fixed costs: Fixed manufacturing overhead Fixed selling and administrative Before-tax profit Income taxes ($1,200 × 30%) After-tax profit ©Cambridge Business Publishers, 2009 8,195 2,980 1,200 100% 580 30% 70% 1,780 1,200 360 $ 840 Multiple Product Break­Even Point Applicable when unit information is not available when a company sells more than one product Dollar break­even point = Fixed costs Contribution margin ratio Fixed costs + Desired profit Contribution margin ratio Target dollar sales volume = ©Cambridge Business Publishers, 2009 Sales Mix Analysis Sales mix When sales mix is constant, the basic cost­ volume­profit model can be used effectively When sales mix is not constant, must determine average unit contribution margin or average contribution margin ratio for each alternative mix The relative portion of unit or dollar sales that are derived from each product ©Cambridge Business Publishers, 2009 It is now 2010 and Chillin’ Time has two products­­ice cream bars and popsicles, with the following information: Ice Cream Bars Popsicles Total Unit Sales Analysis Unit sales Selling price per unit Variable cost per unit Fixed costs per month Sales revenue Variable costs Contribution margin Contribution margin ratio 5,000 $2.00 $1.10 5,000 $0.80 $0.40 10,000 $3,400 $10,000 5,500 $ 4,500 0.450 $4,000 2,000 $2,000 0.500 $14,000 7,500 $ 6,500 Current sales mix based on units: 5,000 to 5,000 or 1 to 1. Current sales mix based on units: 5,000 to 5,000 or 1 to 1. Chillin’ Time sells 1 ice cream bar for every popsicle. ©Cambridge Business Publishers, 2009 Unit Multiproduct Break­Even Example Average contribution margin per unit = [($0.90 × 1) + ($0.40 × 1)] ÷ 2 units = $0.65 Unit break­even point = = Fixed costs Contribution margin per unit $3,400 $0.65 = 5,230.8 ≈ 5,231 units Ice cream bars: 5,231 × 1/2 = 2,616* and Popsicles: 5,231 × 1/2 = 2,616* ©Cambridge Business Publishers, 2009 *rounded Unit Multiproduct Break­Even Example If the sales mix changes to 4:1, how much will the unit break­even sales volume be? Average contribution margin per unit = [($0.90 × 4) + ($0.40 × 1)] ÷ 5 units = $0.80 Unit break­even point with new sales mix = = Fixed costs Contribution margin per unit $3,400 $0.80 = 4,250 units Ice cream bars: 4,250 × 4/5 = 3,400 and Popsicles: 4,250 × 1/5 = 850 ©Cambridge Business Publishers, 2009 Comparing Break­Even Example Break­even units Sales mix 1 to 1 Sales mix 4 to 1 Ice cream bars: 5,231 × 1/2 = 2,616* and Popsicles: 5,231 × 1/2 = 2,616* Ice cream bars: 4,250 × 4/5 = 3,400 and Popsicles: 4,250 × 1/5 = 850 ©Cambridge Business Publishers, 2009 The change in sales mix causes the total number of units needed to break even to change because of the different contribution margins for the two products. Current sales mix in dollars is 10,000 to 4,000 or about 71% to 29%. How much is the break­even sales volume in dollars? Average contribution margin ratio = $6,500 ÷ $14,000 = 0.464 Dollar Multiproduct Break­Even Example Dollar break­even point with new sales mix = = Fixed costs Average Contribution margin ratio Ice cream bars: $7,328 × 0.71 = $5,203 and Popsicles: $7,328 × 0.29 = $2,125 $3,400 0.464 = $7,328 ©Cambridge Business Publishers, 2009 Current sales mix in dollars is 10,000 to 4,000 or about 71% to 29%. If the sales mix changes to a 60% to 40% ratio, how much will the break­even sales volume in dollars be? Average contribution margin ratio = [(0.45 × 0.60) + (0.50 × 0.40)] = 0.470 Dollar Multiproduct Break­Even Example Dollar break­even point with new sales mix = = Fixed costs Average Contribution margin ratio Ice cream bars: $7,234× 0.60 = $4,341* and Popsicles: $7,234 × 0.40 = $2,894* $3,400 0.470 = $7,234 ©Cambridge Business Publishers, 2009 Comparing Break­Even Example Break­even sales dollars Sales mix 71% to 29% Sales mix 60% to 40% Ice cream bars: $7,328 × 0.71 = $5,203 and Popsicles: $7,328 × 0.29 = $2,125 Ice cream bars: $7,328 × 0.60 = $4,341 and Popsicles: $7,328 × 0.40 = $2,894 The change in sales mix causes the sales dollars needed to break even to change because of the different contribution margins for the two products. ©Cambridge Business Publishers, 2009 Operating Leverage What is operating leverage? High degree of operating leverage A measure of the extent that an organization’s costs are fixed Signals the existence of a high portion of fixed costs Degree of operating = leverage Contribution margin Income before taxes = ©Cambridge Business Publishers, 2009 Operating Leverage Risk and Opportunity Sales Increase High operating leverage High opportunity for profit increases Low operating Low opportunity Low risk of The higher the degree of operating leverage leverage for profit loss The greater the opportunity for profit with increases Sales Decrease High risk of loss increases in sales, AND The greater the risk of large losses when sales decrease ©Cambridge Business Publishers, 2009 Measuring Expected Change in Profit Taco King and Mexi Land are competitors and reported the same sales revenue and before-tax profit during May: Taco King Mexi Land If sales drop by 20% for both, which company suffers more? Degree of operating leverage Decrease in profit Taco King Mexi Land Sales Variable costs Contribution margin Fixed costs Before-tax profit $40,000 (22,000) 18,000 (8,000) $10,000. $40,000. (8,000) 32,000. (22,000) $10,000. $18,000 $10,000 = 1.8 $32,000 $10,000 = 3.2 1.8 × 20% = 36% Decline in Profit 3.2 × 20% = 64% Decline in Profit Mexi Land’s higher operating leverage results in a larger profit decline. ©Cambridge Business Publishers, 2009 Profitability Analysis Considerations Limitation Only one activity cost driver used Unit­level approach based on the Appendix 15A assumption that units sold or sales dollars is the only cost driver Solution Use a cost hierarchy approach that incorporates nonunit as well as unit­ level activity cost drivers ©Cambridge Business Publishers, 2009 Multi­Level Contribution Income Statement With Income Taxes Sales Less unit-level costs: Cost of goods sold ($3,000,000 x 0.80) Unit level contribution margin Cost of processing order (3,200 orders x $20) Order-level contribution margin Less customer-level costs: Mail, phone, sales visits, recordkeeping, etc. (400 customers x $200) Customer-level contribution margin Less facility-level costs: Depreciation, manager salaries, insurance, etc. Before-tax profit Income taxes ($336,000 x 0.40) After-tax profit ©Cambridge Business Publishers, 2009 Appendix 15A $ 3,000,000. (2,400,000) 600,000. (64,000) 536,000. (80,000) 456,000. (120,000) 336,000. 134,400. $ 201,600. Unit­Level Break­Even Example The following costs have been determined based on the multi­level break­even contribution income statement: Type of Activity Unit-level Order-level Customer-level Facility-level Cost $0.80 per sales dollar $64,000 $80,000 $120,000 Appendix 15A Assuming no changes in other costs, what is the unit­ level break­even dollar sales volume: Order+ Customer- + Facilitylevel costs level costs level costs Contribution margin ratio = [$64,000 + $80,000 + $120,000] ÷ [1 ‒ 0.8] = $1,320,000 ©Cambridge Business Publishers, 2009 ...
View Full Document

This note was uploaded on 11/08/2010 for the course ACC 5056 taught by Professor J.goslinga during the Spring '10 term at University of Florida.

Ask a homework question - tutors are online