It deals with how operating profit is affected by changes in variable costs, fixed costs, selling price per unit and the sales mix of two or more different products.
CVP Scenario Amy Winston, the manager of food services for one of Boeing’s plants, is trying to decide whether to rent a line of snack vending machines. Although individual snack items have various acquisition costs and selling prices, Winston has decided that an average selling price of $1.50 per unit and an average acquisition cost of $1.20 per unit will suffice for purposes of this analysis. She predicts the following revenue and expense relationship
CVP Scenario Per Unit Percentage of Sales Selling price $1.50 100% Variable cost of each item 1.20 80 Selling price less variable cost $ .30 20% Monthly fixed expenses: Rent $3,000 Wages for replenishing and servicing 13,500 Other fixed expenses 1,500 Total fixed expenses per month $18,000 100000 units
18,000 30,000 90,000 120,000 138,000 $150,000 0 10 20 30 40 50 60 70 80 90 100 Units (thousands) Dollars 60,000 Total Expenses Sales Net Income Area Break-Even Point 60,000 units or $90,000 Net Loss Area A C D B Fixed Expenses Variable Expenses Net Income Graphing the CVP Relationship
Assumptions of CVP Analysis Expenses may be classified into variable and fixed categories. The behavior of revenues and expenses is accurately portrayed and is linear over the relevant range. Selling prices per unit and variable costs per unit do not change with the level of sales.
Assumptions of CVP Analysis In multi product companies, the Sales Mix remains constant. The inventory level does not change significantly during the period. That is, the number of units sold equals the number of units produced.
Objective 5 Calculate break-even sales in total dollars and total units
Methods to Calculate break-even sales The graphical method The equation method The contribution margin method The break-even point is the level of sales at which revenue equals expenses and net income is zero
Calculate break-even sales Equation Method Sales-Variable expenses-fixed expenses=net income Unit sales price* number of units unit of variable costs * number of units Fixed Expenses Net Income
Calculate break-even sales Equation Method Let N = the number of units to be sold to break even. Then for the vending machine example Variable Fixed Sales – Expenses – Expenses = net income $1.50N – $1.20N – $18,000 = 0 $.30N = $18,000 N = $18,000 ÷ $.30 N = 60,000 Units To express BEP in terms of dollar sales rather than the number of units, multiply the number of units (60000) by selling price per unit ($1.50) to find the BEP in terms of dollar sales $90000
Calculate break-even sales Contribution – Margin Method Contribution Margin Method: The sales price per unit minus the variable cost per unit (Marginal income per unit that every unit sold generates. Contribution margin Per Unit Selling price $1.50 Variable costs 1.20 Contribution margin$ .30 Contribution margin ratio Per Unit % Selling price 100 Variable costs 80 Contribution margin 20
Calculate break-even sales Contribution – Margin Method Total Contribution margin: Total number of units sold times the unit contribution margin (Total number of units sold * Unit contribution margin).
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