1. Cost-Volume-Profit Analysis
Chapter 3
Cost-Volume-Profit Analysis
Prepared by
Diane Tanner
University of North Florida

2. Cost-Volume-Profit (CVP) Analysis2
Cost-Volume-Profit (CVP) Analysis
A very powerful management tool
Helps explain interactions between
Selling prices of products
Volume or level of activity
Per unit variable costs
Total fixed costs
Mix of products sold

3. CVP Terminology Selling price Sales revenue Total cost3
Selling price
The amount for which one unit of product is sold
Sales revenue
Selling price per unit multiplied by the number of units sold
Total cost
Total variable costs plus total fixed costs
Variable cost (VC)
A variable cost per unit of product
Total fixed costs (TFC)

4. Cost and Profit Equations
Cost equation Total cost = (VC/unit)(# of units) + Total FC i.e., TC = VCx + TFC Profit equation Sales revenue ‒ Total cost = Profit Or (SP/per unit)(# of units) ‒ Total cost = Profit SPx ‒ VCx ‒ TFC = profit
Parallels the components on the variable costing income statement

5. Assumptions in CVP Analysis
Costs can be accurately separated into their variable and fixed components
Both unit variable costs and total fixed costs remain constant within the relevant range
Inventory levels are zero or do not change
Costs are linear
Sales mix is constant

6. CVP Graph Three primary CVP graph lines Total Revenue Total Cost6
Three primary CVP graph lines
Total Revenue
Dollars
Total Cost
Fixed costs
Units

7. Breakeven Point The point where Break-even profit equation
Sales revenue equals total cost
Contribution margin equals fixed costs
Profit is zero
Break-even profit equation
SPx – VCx – TFC = 0
Activity below the break-even point creates a loss
Activity above the break-even point generates a profit

8. Breakeven Point Total sales revenue = total expenses = VCx + FC8
Total sales revenue = total expenses = VCx + FC
Total Revenue
Profit Area
Break-even point
Dollars
Total Cost
Loss Area
Fixed costs
Units

9. Target Profit
Target profit is the level of profit a company desires to achieve
CVP can be used to determine the sales volume needed to achieve a target profit
‘Before tax’ target profit equation
SPx – VCx – TFC = Target Profit
‘After tax’ target profit equation
(SPx – VCx – TFC)(1 – TR) = Target Profit
Where TR is the income tax rate

10. Margin of Safety 10
Margin of safety is……
The amount by which sales (revenue or units) can drop before losses begin to be incurred
A cushion available to management before trouble (a loss) occurs
Can be measured in
Unit sales or
Sales dollars
Margin of safety = Total sales ‒ Break-even sales

11. What-If Analysis
Using the profit equation, managers can change selected variables to see the effect on profit, units to be sold, or sales revenue.
Variables to be changed
Selling price
Fixed costs
Variable costs

12. Operating Leverage What is cost structure?12
Operating Leverage
What is cost structure?
The relative proportion of fixed and variable costs in an company
Higher proportions of fixed costs compared to variable costs
More sensitive to changes in sales
More risk
Higher operating leverage
Higher proportions of variable costs compared to fixed costs
Less sensitive to changes in sales
Less risk
Lower operating leverage

13. Degree of Operating Leverage13
Degree of Operating Leverage
A measure of how sensitive net operating income is to percentage changes in sales
A risk indicator
Contribution Margin Net Operating Income
Degree of Operating Leverage =
Company A Company B
$70,000
$18,000
$49,000
$18,000
= 3.89
= 2.72
Higher degree of operating leverage indicates higher proportion of fixed costs and higher risk.

14. Pushing Products to Customers14
Goal is to generate the largest profit
Push the product with the higher contribution margin per unit
If customers prefer to buy one product and do not care which one they buy
Push the product with the higher contribution margin ratio (i.e., the highest profit out of each sales dollar)
If customers prefer to spend a fixed sum of money and do not care which products they buy

15. Sales Mix What is sales mix?15
What is sales mix?
The relative proportion in which a company’s products are sold
Based on the premise that different products have different selling prices, cost structures, and contribution margins
Two ways to express
Unit sales mix
2000 : 8000
1 : 4
Buckets
Pails
Units
2,000
8,000
Sales
$4,000
$6,000
Expenses
$1,600
$3,500
Profit
$2,400
$2,500
Revenue sales mix
4000 : 6000
2 : 3

16. Multiproduct Analysis
Two approaches
Contribution approach
Based on the weighted average contribution margin for all products combined
Bundle approach
Based on the unit contribution margins of each product weighted by the sales mix

17. Weighted Average Approach Breakeven in Units17
To determine the breakeven point in units for multiple products
Calculate the weighted average CM per unit
Total CM / total units
Use the CM per unit in the profit equation to calculate breakeven point in units
This is the unit breakeven point for all products
Calculate the unit sales mix
Multiply the sales mix proportion by the unit breakeven point for each product
Round up to nearest full unit

18. Weighted Average Approach Breakeven in Revenue Dollars18
To determine the breakeven point in sales dollars for multiple products
Calculate the weighted average CM ratio
Total CM / Total sales revenue
Use the CM ratio in the profit equation to calculate breakeven point in sales revenue
This is the $ breakeven point for all products
Calculate the revenue sales mix
Multiply the sales mix proportion by the revenue breakeven point for each product

19. Bundle Approach Where CM = contribution margin, and SM = sales mix
Determine the unit contribution margin for each product
Determine the unit sales mix
Set up a profit equation that uses these two components as:
(CM1)(SM1)x + (CM2)(SM2)x – TFC = 0
Where CM = contribution margin, and SM = sales mix
The answer is a ‘per bundle’ amount. Multiply the sales mix for each product separately by the ‘per bundle’ amount.
To determine breakeven in sales dollars, multiply the units by the selling price per unit

20. The End