COST-VOLUME-PROFIT RELATIONSHIP CHAPTER 5

CVP Formula Sx = VCx + FC + P S= Selling Price X= Sales Volume VC = Variable Cost per unit FC = Fixed Cost P= Profit Very powerful equation If all else fails just work the equation

Things you can find out using CVP formula Breakeven points Units to sell to get a certain profit How many more to sell if Fixed Cost increased Selling Price

Apply CVP Formula Selling Price $36 Variable Cost $24 per unit Fixed Costs $12,000 Units 2,000 Profit= ? Put in CVP formula

CONTRIBUTION MARGIN The amount that contributes to fixed costs and profits i.e Contribution Calculated In per unit, $ and in % $100 Sales 60 VC $ 40 CM 40% Ratio ($40/$100= .40) 35 FC $ 5 NI

CONTRIBUTION MARGIN FORMAT Income Statement SALES -VARIABLE COST =CONTRIBUTION MARGIN - FIXED EXPENSES NET OPERATING INCOME Exercise 5-1 page 213

Application of CVP Data Exercise 5-5 page 214 1- Increase advertising budget 2- Increase quality of product

BREAK EVEN (BE) IN UNITS & $ The units or $ that will cover the fixed costs with no profit. Sx – VCx= FC BE in equation method FC/CM% = BE$ CM Method You can determine: BE in units, BE in $ Exercise 5-7 pg 214

PROFIT PLANNING Answers these questions: How many do I need to sell to make $100,000 profit For example: If I reduce my fixed costs by $2,000 and increase my sales in units by 100 how will my profit change?

Target Profit Analysis Formula for units to make a $ profit FC + Profit Unit CM X sales price = Sales to attain target profit Exercise 5-6 pg 214 1- equation method 2- CM approach

Margin of Safety (MS) Amount you can drop before losses are incurred How much can our sales drop before we start losing money Every company has a different % because each is structured differently How much excess you have over break even. How much you have after you cover your fixed costs.

Margin of Safety formula Budgeted Sales – BE$ = MS$ MS$/Budgeted Sales=MS% Example: Sales $100,000 BE$ 87,500 MS$ $ 12,500 / 100,000 = 12.5% Exercise 5-8 page 214

Operating Leverage (OL) pg 202 How sensitive income is to a % change in Sales $ How a % change in Sales volume will affect profits. It is a Multiplier If OL is high a small % change in Sales will reuslt in a higher change in NI

Operating Leverage Formula Contribution Margin $ Net Income in $ It OL is 2 and sales increased by 5% then net income will increase by 10% Exercise 5-9 pg 215

Operating leverage proof Sales 100,000 110,000 VC 60,000 66,000 CM 40,000 44,000 FC 35,000 35,000 NI 5,000 9,000 $4,000 OL 40,000/5000= 8 times x 10% 80% x $5000 = $4000

CM Ratio Another way to determine effect on net income Change in Net Income with the change in Total Sales If we sell 10,000 more units, how would our net income increase? 10,000 X25%CM= 2500 change in units X $24 per unit = $60,000 increase in NI How much would our net income increase if our sales increase by $240,000 $240,000 X 25% = $60,000

Sales Mix Multi Product CM Proportions in which a company’s products are sold Mix that will yield the greatest profit Steps to determine 1- Total all sales 2- VC % for each product and total sales 3- = CM% for all sales 4- Determine total BE$ FC/CM% 5- Each product % of total sales X BE$ 6- Use VC% for each product for VC 7- =CM for each product = total fixed costs Page 206 Exhibit 5-4 Exercise 5-10, pg 215