Cost-Volume-Profit Analysis Chapter 3

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Cost-Volume-ProfitAnalysisChapter 3

• Accounting Principles II
• AC 2102 - Fall Semester, 1999

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Overview of CVP Analysis

• Is a powerful tool for planning decision making
• Focuses on the interrelationships between costs,
  quantity sold, and price
• Can quickly show the economic impact of different
  operational/financial circumstances and
  decisions
• Can be a valuable tool to identify economic
  problems assist in pinpointing the necessary
  solution

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Some of the Key IssuesCVP Analysis Addresses

• The number of units or dollars of revenue
  required to break-even
• The impact of a given reduction in fixed costs on
  the break-even point and overall profitability
• The impact of an increase in price on
  profitability
• The sensitivity of profits to changes in prices,
  costs or volume levels

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Break-Even Point In Units

• The break-even point is where total revenues
  equals total cost
• The point of zero profit
• In terms of units, the break-even point is the
  number of units sold which will result in a zero
  profit level
• Several work steps are required to perform a
  break-even analysis

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Work Steps Required To Perform a
Cost-Volume-Profit Analysis

• 1st Step Define a unit
• 2nd Step Separate costs into fixed and
  variable components
• Note this second step requires the separating of
  mixed costs into their fixed and
  variable components
• 3rd Step Apply the appropriate
  mathematical analysis and
  equations

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Some Possible Definitions of a Unit(i.e.,
units produced and sold)

• Automobile Company Cars
• Hospital Patient-Days
• Hotel (1) Guest-Days
• (2) Number of Occupied Rooms
• (3) of Rooms Occupied
• Soft-drink Company Cans of 12-ounce
  equivalents
• Pharmacy Cannot be defined in units

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Separating Costs Into TheirFixed Variable
Components

• In most problems presented in text books this
  step has already been performed
• i.e., in most C-V-P problems, the costs that are
  fixed and variable are already defined
• It should be clearly understood that in practice
  this is the most difficult step in a C-V-P
  analysis
• In the accounting records costs are only defined
  by nature of the expense (salaries, insurance,
  etc.)
• i.e., the cost behavior pattern of each cost is
  not identified in the accounting records

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Contribution Margin

• Contribution margin is an extremely useful and
  insightful concept
• Two Definitions
• Price - Variable Costs per Unit CM per unit
  or
• Total Revenue - Total Variable Costs
  Total Contribution Margin
• Note It is not the same as Gross Margin
• Gross Margin Revenues - Cost of Goods Sold

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Two Ways of Calculating The Contribution Margin

• Per Unit Basis Contribution Per Unit/Price
  Per Unit
• Contribution Margin Ratio
• Total Contribution Margin/Total Revenues

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Mathematical AnalysisWhen Dealing With Unit Data

• Breakeven Point
• Total Fixed Costs/Contrib. Margin Per Unit
• Sales Required to Achieve Targeted Profit Level
  (Before Taxes)
• (FCTarg. PBT) /Contrib. Margin Per Unit

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Mathematical Analysis When Dealing With Total
Sales Dollars

• Breakeven Point
• Total Fixed Costs/Contrib. Margin Ratio
• Sales Required to Achieve Targeted Profit Level
  (Before Taxes)
• (FCTarg. PBT) /Contrib. Margin Ratio

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Other Key Concepts

• Margin of Safety
• Actual Sales - Breakeven Sales
• - can be expressed in units or sales
  dollars
• Operating Leverage
• The ratio of a firms fixed costs to its
  variable costs
• Degree of Operating Leverage
• Contribution Margin/Operating Income