CVP ANALYSIS

Objectives
Objectives
1. DetermineAfter
the number
ofthis
units that must
studying
After studying this
be sold to chapter,
break even
or
earn
a
target
chapter, you
you
profit.
should
should be
be able
able to:
to:
2. Calculate the amount of revenue required
to break even or to earn a targeted profit.
3. Apply cost-volume-profit analysis in a
multiple-product setting.
4. Prepare a profit-volume graph and a
cost-volume-profit graph, and explain the
meaning of each.

Objectives
Objectives
5. Explain the impact of risk, uncertainty,
and changing variables on cost-volumeprofit analysis.
6. Discuss the impact of activity-based
costing on cost-volume-profit analysis

The Break-Even Point

The break-even point is the point in the
volume of activity where the organizations
revenues and expenses are equal.
Sales
$ 250,000
Less: variable expenses 150,000
Contribution margin
100,000
Less: fixed expenses
100,000
Net income
$
-

Equation Approach
Sales revenue Variable expenses Fixed expenses = Profit

Unit
Sales
sales volume
price in units

Unit
Sales
variable volume
expense in units

($500 X)

($300 X)

$80,000 = $0

($200X) $80,000 = $0
X = 400 surf boards

Contribution-Margin Approach
Consider the following information
developed by the accountant at Curl, Inc.:

Sales (500 surf boards)

Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

Total
$250,000
150,000
$100,000
80,000
$ 20,000

Per Unit
$
500
300
$
200

Percent
100%
60%
40%

Contribution-Margin Approach
For each additional surf board sold, Curl
generates $200 in contribution margin.

Sales (500 surf boards)

Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

Total
$250,000
150,000
$100,000
80,000
$ 20,000

Per Unit
$
500
300
$
200

Percent
100%
60%
40%

Contribution-Margin Approach
Fixed expenses
Break-even point
=
Unit contribution margin
(in units)
Sales (500 surf boards)
Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

$80,000
$200

Total
$250,000
150,000
$100,000
80,000
$ 20,000

Per Unit
$
500
300
$
200

= 400 surf boards

Percent
100%
60%
40%

Contribution-Margin Approach
Here is the proof!

Sales (400 surf boards)

Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

400 $500 = $200,000

Total
$200,000
120,000
$ 80,000
80,000
$
-

Per Unit
$
500
300
$
200

Percent
100%
60%
40%

400 $300 = $120,000

Contribution Margin Ratio

Calculate the break-even point in sales dollars
rather than units by using the contribution
margin ratio.

Contribution margin
Sales
Fixed expense
CM Ratio

= CM
Ratio

Break-even point
=
(in sales dollars)

Contribution Margin Ratio

Sales (400 surf boards)

Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

$80,000
40%

Total
$200,000
120,000
$ 80,000
80,000
$
-

Per Unit
$
500
300
$
200

$200,000 sales

Percent
100%
60%
40%

Target Net Profit

We can determine the number of surfboards
that Curl must sell to earn a profit of $100,000
using the contribution margin approach.
Fixed expenses + Target profit
Unit contribution margin

Units sold to earn

the target profit

$80,000 + $100,000
= 900 surf boards
$200

Equation Approach
Sales revenue Variable expenses Fixed expenses = Profit
($500 X)

($300 X) $80,000 = $100,000

($200X) = $180,000
X = 900 surf boards

Applying CVP Analysis

Safety Margin
The difference between budgeted sales
revenue and break-even sales revenue.
The amount by which sales can drop before
losses begin to be incurred.

Safety Margin
Curl, Inc. has a break-even point of $200,000.
If actual sales are $250,000, the safety margin is
$50,000 or 100 surf boards.

Sales
Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

Break-even
sales
400 units
$ 200,000
120,000
80,000
80,000
$
-

Actual sales
500 units
$ 250,000
150,000
100,000
80,000
$
20,000

Changes in Fixed Costs

Curl
Curl is
is currently
currently selling
selling 500
500 surfboards
surfboards per
per
year.
year.
The
The owner
owner believes
believes that
that an
an increase
increase of
of
$10,000
$10,000 in
in the
the annual
annual advertising
advertising budget,
budget,
would
would increase
increase sales
sales to
to 540
540 units.
units.
Should
Should the
the company
company increase
increase the
the advertising
advertising
budget?
budget?

Changes in Fixed Costs

540
540 units
units $500
$500 per
per unit
unit == $270,000
$270,000
$80,000
$80,000 ++ $10,000
$10,000 advertising
advertising == $90,000
$90,000

Changes in Fixed Costs

Sales
Sales will
will increase
increase by
by
$20,000,
$20,000, but
but net
net income
income
decreased
decreased by
by $2,000.
$2,000.

Changes in Unit
Contribution Margin
Because of increases in cost of raw materials,
Curls variable cost per unit has increased
from $300 to $310 per surfboard. With no
change in selling price per unit, what will be
the new break-even point?
($500 X)

($310 X) $80,000 = $0

X = 422 units (rounded)

Changes in Unit
Contribution Margin
Suppose Curl, Inc. increases the price of
each surfboard to $550. With no change
in variable cost per unit, what will be the
new break-even point?
($550 X)

($300 X) $80,000 = $0
X = 320 units

Predicting Profit Given Expected

Volume
Given:

Given:

Fixed expenses
Unit contribution margin
Target net profit

Fixed expenses
Unit contribution margin
Expected sales volume

Find: {reqd sales volume}

Find: {expected profit}

Predicting Profit Given

Expected Volume
In the coming year, Curls owner expects to sell
525 surfboards. The unit contribution margin is
expected to be $190, and fixed costs are
expected to increase to $90,000.
Total contribution

Fixed cost = Profit

($190 525) $90,000 = X

X = $99,750 $90,000
X = $9,750 profit

CVP Analysis with Multiple

Products
For a company with more than one product,
sales mix is the relative combination in which a
companys products are sold.
Different products have different selling prices,
cost structures, and contribution margins.

Lets assume Curl sells surfboards and sail

boards and see how we deal with breakeven analysis.

CVP Analysis with Multiple

Products
Curl provides us with the following
information:

CVP Analysis with Multiple

Products
Weighted-average unit contribution margin

$200 62.5%
$550 37.5%

CVP Analysis with Multiple

Products
Break-even point
Break-even
Fixed expenses
=
point
Weighted-average unit contribution margin
Break-even
=
point

$170,000
$331.25

Break-even
= 514 combined unit sales
point

CVP Analysis with Multiple

Products
Break-even point
Break-even
= 514 combined unit sales
point

Assumptions Underlying
CVP Analysis
Selling price is constant throughout
the entire relevant range.
Costs are linear over the relevant
range.
In multi-product companies, the sales
mix is constant.
In manufacturing firms, inventories do
not change (units produced = units
sold).

CVP Relationships and

the Income Statement

CVP Relationships and

the Income Statement

Cost Structure and Operating

Leverage
The cost structure of an organization is the
relative proportion of its fixed and variable
costs.
Operating leverage is . . .
the
the extent
extent to
to which
which an
an organization
organization uses
uses fixed
fixed
costs
costs in
in its
its cost
cost structure.
structure.

greatest in companies that have a high

proportion of fixed costs in relation to
variable costs.

Measuring Operating Leverage

Operating leverage
factor

Contribution margin
Net income

Actual sales
500 Board
Sales
$ 250,000
Less: variable expenses
150,000
Contribution margin
100,000
Less: fixed expenses
80,000
Net income
$
20,000

$100,000
$20,000

= 5

Measuring Operating Leverage

A measure of how a percentage change in
sales will affect profits. If Curl increases its
sales by 10%, what will be the percentage
increase in net income?
Percent increase in sales
Operating leverage factor
Percent increase in profits

10%
5
50%

Measuring Operating Leverage

A firm with proportionately high fixed costs has

relatively high operating leverage On the other
hand, a firm with high operating leverage has a
relatively high break-even point.

Effect of Income Taxes

Income taxes affect a companys
CVP relationships. To earn a
particular after-tax net income, a
greater before-tax income will be
required.

Target after-tax net income

1 - t

Before-tax
=
net income

End of Chapter 8
We made
it!