Chapter 7 - Revision Notes

Chapter 7 - Revision Notes - Chapter 7 Cost Volume Profit...

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Chapter 7 Cost, Volume, Profit Analysis I. Introduction Cost, volume, profit (CVP) analysis is a management tool that uses the relationship between costs, sales volume and profits (in either graphic or equation form) for decision-making. Exhibit 2 provides a graphic explanation of the relationship between costs, sales volume and profits. CVP Graph 0 5000 10000 15000 20000 0 200 400 Room Sales Dollars Revenue Fixed Cost Total Cost Break Even Point is at 175 rooms or 10500$ Revenue Loss Zone Profit Zone As shown in this graph, the breakeven point is that level of sales volume at which total revenues equal total costs. Assumptions and Limitations Fixed cost remains unchanged during the period considered Variable costs vary directly in proportion to sales volume Revenues are directly proportional to sales volume All mixed costs can be divided into their fixed and variable components All costs can be allocated to individual operated departments The CVP model does not consider qualitative factors II. Basic CVP Terminology
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1. Variable Cost Ratio (VCR) Measured as (Variable Cost/Total Revenue), the VCR refers to that portion of the revenue dollar used to pay all variable costs. 2. Contribution margin (CM) Measured as (Revenue – Variable Costs), the CM refers to that portion of total revenue used to cover fixed costs and profits.
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