1. Cost-Volume-Profit Analysis

2. The Contribution Format
Used primarily for external reporting.
Used primarily by management.

4. Contribution-Margin Ratio
Sales revenue, variable expenses and contribution for Micro Wave can be expressed as a percentage of sales

5. Contribution Margin Method to Determine Break-even
The contribution margin method is a variation of the equation method.
Fixed expenses
Unit contribution margin =
Break-even point
in units sold
Break-even point in
total sales dollars
Fixed expenses
CM ratio =

6. CVP Graph
Total Sales
Total Expenses
Dollars
Fixed expenses
Units

7. CVP Graph
Profit Area
Dollars
Break-even point
Loss Area
Units

8. Break-even Reduction
Micro is currently selling 500 ovens per month. Break-even units are 400 per month under the current cost structure.
What would be the break-even units if fixed costs decrease to $70,000?
What would be the break-even units if variable costs were reduced to $250?
What would be the break-even units if selling price was increased to $513.33?

9. Target Operating Profit - CM Approach
Original contribution margin formula:
Break Even Point in Units = Fixed Expenses Contribution Margin per Unit
Target operating profit modification:
Units Sold to Earn Target Profit = Fixed Expenses +Target Op. Profit Unit Contribution Margin

10. After-Tax Profit Targets
Net income = Operating profit – Income taxes
= Operating profit – (Tax rate x Operating profit)
= Operating profit (1 – Tax rate) Or
Operating profit =
Net income
(1 – Tax rate)

11. After-Tax Profit Targets
Fisher Company has a selling price of $40 for its only product. Variable cost per unit is $24, and fixed costs are $800,000 for the year. The Company wants to achieve an annual net income (after taxes) of $487,500. How many units must it sell if its income tax rate is 35 percent.

12. Should the increase in advertising be made?
Sensitivity Analysis – Fixed Costs
Micro Wave Co. is currently selling 500 ovens per month
The sales manager believes that an increase of $10,000 in the monthly advertising budget would increase sales of ovens to 540 per month
Should the increase in advertising be made?

13. Change in Variable Costs and Sales Volume
Micro Wave management is contemplating the use of higher-quality components, which would increase variable costs by $15 per oven. However, the sales manager predicts that the overall higher quality would increase sales to 600 ovens per month. Should the higher quality components be used?

14. Change in Fixed Cost, Sales Price, and Sales Volume
To increase sales, the sales manager would like to cut the selling price by $40 per oven and increase the advertising budget by $30,000 per month. The sales manager believes that if these two steps are taken, unit sales will increase by 60% to 800 ovens per month. Should the changes be made?

15. Change in Variable Cost, Fixed Cost, and Sales Volume
The sales manager would like to place the sales staff on commission basis of $40 per oven sold, rather than on flat salaries that now total $10,000 per month. The sales manager is confident that the change will increase monthly sales by 15% to 575 ovens per month. Should the change be made?

16. Change in Regular Sales Price
The company has an opportunity to make a bulk sale of 200 ovens to a wholesaler if an acceptable price can be worked out. This sale would not have any effect on the company’s regular sales. What price per oven should be quoted to the wholesaler if Micro wants to increase its Operating profits by $5,000?

17. The Margin of Safety
Excess of budgeted (or actual) sales over the break-even volume of sales. The amount by which sales can drop before losses begin to be incurred.
Margin of safety = Total sales - Break-even sales
Let’s calculate the margin of safety for Micro

18. The Margin of Safety
Micro has a break-even point of $200,000. If actual sales are $250,000, the margin of safety is $50,000 or 100 ovens.

19. The Margin of Safety
The margin of safety can be expressed as 20% of sales. ($50,000 ÷ $250,000)

20. Cost Structure and Profitability
Alpha
Beta
Gamma
Amount %
Sales
$800,000
100%
Variable Expenses
400,000
50%
300,000
37.5%
200,000
25%
Contribution Margin
500,000
62.5%
600,000
75%
Fixed Expenses
Op. Income
$ 100,000

21. Effect on Profit of 10% Increase in Sales Revenue
Contribution Margin Ratio
Increase in Op.Income
Alpha
$80, X
50% =
$40,000
+40%
Beta
62.5% =
$50,000
+50%
Gamma
75% =
$60,000
+60%

22. Break-Even Points Fixed Expenses $300,000 / $400,000 / $500,000 /
$300, /
$400, /
$500, /
Contribution Margin Ratio
50% =
62.5% =
75% =
Break-Even Sales Revenue
$600,000
$640,000
$666,667
Alpha
Beta
Gamma

23. Break-Even Sales Revenue
Margin of Safety
Actual Sales Revenue
Break-Even Sales Revenue
Margin of
Safety
Alpha
Beta
Gamma
$800,
800,
800,
$600, =
640, =
666, =
$200,000
160,000
133,333

24. Definition of Operating Leverage
The relative mix of a firm’s fixed and variable costs determines its operating leverage.
At a given level of sales:
Degree of operating = Contribution Margin
leverage Operating Income
The higher a firm’s fixed cost as compared to its variable cost, the greater its operating leverage.
Operating leverage acts like a multiplier. The greater the operating leverage, the greater the change in operating income for a given change in sales.
Let’s calculate the operating leverage for each firm.

25. Application of Operating Leverage
At a given level of sales, the operating leverage is a measure of how a given percentage change in sales will affect operating profits.
In fact, the operating profit will increase by the operating leverage times the percentage change in sales.
For a 10% increase in sales , Firm Alpha’s operating income increased 40% (4 times 10%).
For a 10% increase in sales , Firm Beta’s operating income increased 50% (5 times 10%).
For a 10% increase in sales , Firm Gamma’s operating income increased 60% (6 times 10%).

26. Break-even Analysis (in Units) with Multiple Products
Curl Company provides us with the following information:
Fixed cost is $120,000. What is the break-even point in units? What are the sales of Surfboards and Sailboards at the break-even point?

27. Break-even Analysis (in Sales Dollars) with Multiple Products
Curl’s Contribution Margin income statement is shown below:
$150,000
$450,000
= 33.3%
What is the break-even point in Sales? What are the sales of Surfboards and Sailboards at the break-even point?