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Cost-Volume-Profit Analysis Managerial Accounting Prepared by Diane Tanner University of North Florida Chapter 7

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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 CVP assesses the relationship between costs (fixed and variable), activity levels, and profits. 2

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CVP Terminology 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) 3

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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 Or SPx ‒ VCx ‒ TFC = profit 4 Parallels the components on the variable costing income statement

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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 5

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Breakeven Point The point where Sales revenue equals total cost Contribution margin equals total 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 6

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Breakeven Point Total fixed costs Units Dollars Total Cost Total Revenue 7 Profit Area Loss Area Break-even point Total sales revenue = Total expenses = VCx + TFC

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Breakeven Example 8 How many units and how much sales dollars are needed to break even? Set up the profit equation with profit equal to 0. Let X = number of units SPx – VCx – TFC = Profit 50x – 30x – 8,000 = 0 x = 400 units or 400 × $50 = $20,000 sales revenue If the company sells 400 widgets, which generates $20,000 of sales revenue, profit will be zero.

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Target Profit Example 9 Set up the profit equation with profit equal to $12,000. Let X = number of units SPx – VCx – TFC = Profit 50x – 30x – 8,000 = 12,000 x = 1,000 units or 1,000 × $50 = $50,000 sales revenue If the company sells 1,000 widgets, it will generate $50,000 of sales revenue and $12,000 of profit. How many units and how much sales dollars are needed to earn a profit of $12,000?

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Additional Units & Additional Sales Dollars Profit is zero if 400 units are sold. 10 By how much will profit increase if 3 more units are sold? For the Month of June TotalPer Unit Sales (400 units) $ 20,000 $ 50 Less: variable expenses 12,000 30 Contribution margin 8,000 $ 20 Less: fixed expenses 8,000 Net income $ 0 Profit increase = Additional units × CM per unit = 3 × $20 = $60 By how much will profit increase if sales increase by $200? Profit increase = Additional sales dollars × CM ratio = $200 × 40.00%= $80 CM ratio = $20/$50 = 40.00%

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Margin of Safety Margin of safety is…… The amount by which sales 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

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Margin of Safety Example Margin of safety in units = Actual sales – BEP sales = 500 – 400 = 100 units Margin of safety in sales dollars = Actual sales$ – BEP sales$ = $25,000 – $20,000 = $5,000 12 A company’s break- even point is 400 units. Actual sales for May total 500 units. How much can sales drop before the manager is ‘in trouble’? A company’s break- even point is 400 units. Actual sales for May total 500 units. How much can sales drop before the manager is ‘in trouble’? Sales can drop by 100 units or $5,000 before a loss occurs.

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13 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 13

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14 The End

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