6 Slide 1 Cost Volume Profit Analysis Chapter 6 INTRODUCTION The Profit Function Breakeven Analysis Differential Cost Analysis

6 Slide 2 The Profit Equation Operating Profit Total Revenue Total Costs =– Operating profit equals total revenue less total costs.

6 Slide 3 The Profit Equation Operating Profit Total Revenue Total Costs = TR – TC =–

6 Slide 4 The Profit Equation Total Revenue Average Selling Price Per Unit Units of Output =× TR = P × X

6 Slide 5 The Profit Equation Total Costs Variable Costs Per Unit Units of Output =× TC = (V × X) + F Fixed Costs +

6 Slide 6 The Profit Equation Now, we’ll expand our original equation for profits! (P × X) - [(V × X) + F] =

6 Slide 7 The Profit Equation Now, we’ll expand our original equation for profits! (P × X) - [(V × X) + F] = (P – V)X – F =

6 Slide 8 Example Here is the information from the Hap Bikes:

6 Slide 9 Example (P – V)X – F =

6 Slide 10 Finding Target Volumes The formula to find a volume expressed in units for a target profit is... Target Volume (units) = Fixed costs + Target profit Contribution margin per unit How many bikes must Hap sell to earn an annual profit of $100,000?

6 Slide 11 Finding Target Volumes Target Volume (units) = Fixed costs + Target profit Contribution margin per unit

6 Slide 12 Proof If Hap sells 900 bikes, its operating profit would be... (P – V)X – F =

6 Slide 13 Finding the Break-Even Point Break-Even Point The Break-Even Point is the volume level where profits equal zero. units target volume in units Ê To find the break-even point in units, we use the target volume in units equation and set the profit to zero. sales dollars target volume in sales dollars Ë To find the break-even point in sales dollars, we use the target volume in sales dollars equation and set the profit to zero.

6 Slide 14 Break-Even in Units Let’s use the Hap Bikes information again. Contribution margin ratio

6 Slide 15 Break-Even in Units Break-Even Volume (units) = Fixed costs + Target profit Contribution margin per unit

6 Slide 16 Break-Even in Sales Dollars = $80,000 + $0.40 Fixed costs + Target profit Contribution margin ratio Break-Even Volume (sales $) =

6 Slide 17 Target Volume in Sales Dollars contribution margin ratio We can calculate the target volume in sales dollars using the contribution margin ratio. Contribution margin per unit Sales price per unit

6 Slide 18 Target Volume in Sales Dollars The equation for finding the target volume in sales dollars is... Fixed costs + Target profit Contribution margin ratio Target Volume (sales $) =

6 Slide 19 Graphic Presentation Consider the following information for Hap Bikes:

6 Slide 20 Graphic Presentation Volume per period (X) Dollars

6 Slide 21 Graphic Presentation Break-even point Dollars Volume per period (X)

6 Slide 22 Using CVP to Analyze Different Cost Structures t Cost structure t Cost structure - The proportion of fixed and variable to total costs of an organization. t Operating leverage t Operating leverage - The extent to which an organization’s costs structure is made up of fixed costs. Let’s look at an example of different costs structures for different companies.

6 Slide 23 Using CVP to Analyze Different Cost Structures

6 Slide 24 Using CVP to Analyze Different Cost Structures Let’s see what happens when both companies experience a 10% increase in sales.

6 Slide 25 Using CVP to Analyze Different Cost Structures

6 Slide 26 Margin of Safety t Excess of projected (or actual) sales over the break-even volume. t The amount by which sales can fall before the company is in the loss area of the break-even graph. Sales Break-even Sales Break-even volume sales volume = Margin of Safety –

6 Slide 27 Margin of Safety Hap is currently selling 500 bikes, and we calculated the break-even to be 400 units ($80,000 fixed costs ÷ $200 contribution margin).