cost-analysis

Sales 2000 x 2000 variable costs 2000 x 800

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Unformatted text preview: ,000 X $800) Contribution margin Fixed costs 1 ,200,000 Net income - What would happen if Leyland sold 2,000 units? Sales (2,000 X $2,000) * Variable costs (2,000 X $800) Contribution margin Fixed costs 1 ,200,000 Net income $1,200,000 Download free ebooks at bookboon.com 20 Break-Even and Target Income Cost Analysis What would happen if Leyland sold only 500 units? Total Sales (500 X $2,000) * P er Unit Ratio $ 1,000,000 $2,000 100% 4 00,000 8 00 40% $ 600,000 $1,200 60% Variable costs (500 X $800) Contribution margin Fixed costs 1 ,200,000 Net income $ (600,000) Notice that changes in volume only impact certain amounts within the “total column.” Volume changes did not impact fixed costs, or change the per unit or ratio calculations. By reviewing the data on the previous page, also note that 1,000 units achieved breakeven net income. At 2,000 units, Leyland managed to achieve a $1,200,000 net income. Conversely, 500 units resulted in a $600,000 loss. 3.3 Graphic Presentation Leyland’s management would probably find the following chart very handy. Dollars are represented on the vertical axis and units on the horizontal: Be sure to examine this chart, taking note of the following items: The total sales line starts at “0” and rises $2,000 for each additional unit. The total cost line starts at $1,200,000 (reflecting the fixed cost), and rises $800 for each additional unit (reflecting the addition of variable cost). “Break-even” results where sales equal total costs. At any given point, the width of the loss area (in red) or profit area (in green) is the difference between sales and total costs. Download free ebooks at bookboon.com 21 Break-Even and Target Income Cost Analysis 3.4 Break-Even Calculations As they say, a picture is worth a thousand words, and that is certainly true for the CVP graphic just presented. However, everyone is not an artist, and you may find it more precise to do a little algebra to calculate the break-even point. Consider that: Break-even results when: Sales = Total Variable Costs + Total Fixed Costs For Leyland, the math turns out this way: (Units X $2,000) = (Units X $800) + $1,200,000 Solving: Step a: (Units X $2,000) = (Units X $800) + $1,200,000 Step b: (Units X $1,200) = $1,200,000 Step c: Units = 1,000 Now, it is possible to “jump to step b” above by dividing the fixed costs by the contribution margin per unit. Thus, a break-even short cut is: e Graduate Programme for Engineers and Geoscientists I joined MITAS because I wanted real responsibili Please click the advert Maersk.com/Mitas Real work Internationa al International opportunities ree wor o ree work placements Month 16 was I was a construction supervisor in the North Sea advising and helping foremen he solve problems s Download free ebooks at bookboon.com 22 Break-Even and Target Income Cost Analysis Break-Even Point in Units = Total Fixed Costs / Contribution Margin Per Unit 1,000 Units = $1,200,000 / $1,200 Sometimes, you may want to know the break-even point in dollars of sales (rather than units). This approach is especially useful for companies with more than one product, where those products all have a similar contribution margin ratio: Break-Even Point in Sales = Total Fixed Costs / Contribution Margin Ratio $2,000,000 = $1,200,000 / 0.60 3.5 Target Income Calculations Breaking even is not a bad thing, but hardly a satisfactory outcome for most businesses. Instead, a manager may be more interested in learning the necessary sales level to achieve a targeted profit. The approach to solving this problem is to treat the “target income” like an added increment of fixed costs. In other words, the margin must cover the fixed costs and the desired profit: Target Income results when: Sales = Total Variable Costs + Total Fixed Costs + Target Income Assume Leyland wants to know the level of sales to reach a $600,000 income: (Units X $2,000) = (Units X $800) + $1,200,000 + $600,000 Solving: Step a: (Units X $2,000) = (Units X $800) + $1,200,000 + $600,000 Step b: (Units X $1,200) = $1,800,000 Step c: Units = 1,500 Again, it is possible to “jump to step b” by dividing the fixed costs and target income by the per unit contribution margin: Units to Achieve a Target Income = (Total Fixed Costs + Target Income) / Contribution Margin Per Unit 1,500 Units = $1,800,000 / $1,200 If you want to know the dollar level of sales to achieve a target net income: Sales to Achieve a Target Income = (Total Fixed Costs + Target Income) / Contribution Margin Ratio $3,000,000 = $1,800,000 / 0.60 Download free ebooks at bookboon.com 23 Break-Even and Target Income Cost Analysis 3.6 Critical Thinking About CVP CVP is more than just a mathematical tool to calculate values like the break-even point. It can be used for critical evaluations about business viability. For instance, a manager should be aware of the “margin of safety.” The margin of safety is the degree to which sales exceed the break-even point. For Leyland, the degree to which sales exceed $2,000,000 (its break-even point)...
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This note was uploaded on 06/07/2013 for the course BA 201 taught by Professor Cuongvu during the Fall '13 term at RMIT Vietnam.

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