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

2. 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

3. 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

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 Or SPx ‒ VCx ‒ TFC = profit 4 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 5

6. 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

7. 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

8. 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.

9. 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?

10. 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%

11. 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

12. 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.

13. 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

14. 14 The End