1. Cost-Volume-Profit Analysis

2. THE BREAK-EVEN POINT(BEP) The break-even point is the point in the volume of activity where the organization’s revenues and expenses are equal. 7-2

3. EQUATION APPROACH Sales revenue – Variable expenses – Fixed expenses = Profit UnitsalespriceSalesvolume in units × UnitvariableexpenseSalesvolume × × X) ($500 × X) × X) ($300 × X)– –$80,000 = $0 X) ($200X)–$80,000 = $0 X = 400 surf boards 7-3

4. CONTRIBUTION-MARGIN APPROACH For each additional surf board sold, Curl generates $200 in contribution margin. Consider the following information developed by the accountant at Curl, Inc.: 7-4

5. CONTRIBUTION-MARGIN APPROACH Fixed expenses Fixed expenses Unit contribution margin Unit contribution margin = Break-even point (in units) $80,000 $80,000 $200 = 400 surf boards 7-5

6. CONTRIBUTION-MARGIN APPROACH Here is the proof! 400 × $500 = $200,000 400 × $300 = $120,000 7-6

7. CONTRIBUTION MARGIN RATIO Calculate the break-even point in sales dollars rather than units by using the contribution margin ratio. Contribution margin Sales = CM Ratio Fixed expense Fixed expense CM Ratio Break-even point (in sales dollars) = 7-7

8. CONTRIBUTION MARGIN RATIO $80,000 $80,00040% $200,000 sales = 7-8

9. GRAPHING COST-VOLUME-PROFIT RELATIONSHIPS Viewing CVP relationships in a graph gives managers a perspective that can be obtained in no other way. Consider the following information for Curl, Inc.: 7-9

10. COST-VOLUME-PROFIT GRAPH Fixed expenses 7-10

11. COST-VOLUME-PROFIT GRAPH Fixed expenses Total expenses 7-11

12. COST-VOLUME-PROFIT GRAPH Fixed expenses Total expenses 7-12

13. COST-VOLUME-PROFIT GRAPH Fixed expenses Total expenses Total sales 7-13

14. COST-VOLUME-PROFIT GRAPH Fixed expenses Total expenses Total sales Break-even point Break-even point Profit area Loss area 7-14

15. PROFIT-VOLUME GRAPH Some managers like the profit-volume graph because it focuses on profits and volume. Some managers like the profit-volume graph because it focuses on profits and volume. Loss area Profit area Break-even point Break-even point 7-15

16. 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 $200 $80,000 + $100,000 $200 = 900 surf boards 7-16

17. EQUATION APPROACH Sales revenue – Variable expenses – Fixed expenses = Profit × X) ($500 × X) × X) ($300 × X)–– $100,000 $80,000 = $100,000 X) ($200X) = $180,000 X = 900 surf boards 7-17

18. EFFECT OF INCOME TAXES Target after-tax net income 1 - t = Before-tax net income Income taxes affect a company’s CVP relationships. To earn a particular after-tax net income, a greater before-tax income will be required. 7-18

19. 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  The difference between budgeted sales revenue and break-even sales revenue.  The amount by which sales can drop before losses begin to be incurred. 7-19

20. 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. 7-20

21. CHANGES IN FIXED COSTS  Curl is currently selling 500 surfboards per year.  The owner believes that an increase of $10,000 in the annual advertising budget, would increase sales to 540 units. Should the company increase the advertising budget?  Curl is currently selling 500 surfboards per year.  The owner believes that an increase of $10,000 in the annual advertising budget, would increase sales to 540 units. Should the company increase the advertising budget? 7-21

22. CHANGES IN FIXED COSTS $80,000 + $10,000 advertising = $90,000 540 units × $500 per unit = $270,000 7-22

23. CHANGES IN FIXED COSTS Sales will increase by $20,000, but net income decreased. decreased by $2,000. Sales will increase by $20,000, but net income decreased. decreased by $2,000. 7-23

24. CHANGES IN UNIT CONTRIBUTION MARGIN Because of increases in cost of raw materials, Curl’s 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? × X) ($500 × X) × X) ($310 × X) –– $80,000 = $0 X = 422 units (rounded) 7-24

25. 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? × X) ($550 × X) × X) ($300 × X) –– $80,000 = $0 X = 320 units 7-25

26. CVP ANALYSIS WITH MULTIPLE PRODUCTS For a company with more than one product, sales mix is the relative combination in which a company’s products are sold. Different products have different selling prices, cost structures, and contribution margins. Let’s assume Curl sells surfboards and sail boards and see how we deal with break-even analysis. For a company with more than one product, sales mix is the relative combination in which a company’s products are sold. Different products have different selling prices, cost structures, and contribution margins. Let’s assume Curl sells surfboards and sail boards and see how we deal with break-even analysis. 7-26

27. CVP ANALYSIS WITH MULTIPLE PRODUCTS Curl provides us with the following information: 7-27

28. CVP ANALYSIS WITH MULTIPLE PRODUCTS Weighted-average unit contribution margin $200 × 62.5% $550 × 37.5% 7-28

29. CVP ANALYSIS WITH MULTIPLE PRODUCTS Break-even point Break-even point = Fixed expenses Weighted-average unit contribution margin Break-even point = $170,000 $331.25 Break-even point = 514 combined unit sales 7-29

30. CVP ANALYSIS WITH MULTIPLE PRODUCTS Break-even point Break-even point = 514 combined unit sales 7-30

31. CVP RELATIONSHIPS AND THE INCOME STATEMENT 7-31

32. CVP RELATIONSHIPS AND THE INCOME STATEMENT 7-32

33. 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 extent to which an organization uses fixed costs in its cost structure.  greatest in companies that have a high proportion of fixed costs in relation to variable costs.  The cost structure of an organization is the relative proportion of its fixed and variable costs.  Operating leverage is...  the extent to which an organization uses fixed costs in its cost structure.  greatest in companies that have a high proportion of fixed costs in relation to variable costs. 7-33

34. MEASURING OPERATING LEVERAGE MEASURING OPERATING LEVERAGE Contribution margin Net income Operating leverage factor = $100,000 $100,000 $20,000 $20,000 = 5 7-34

35. 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? 7-35

36. 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. 7-36

37. END OF CHAPTER 3 We made it! 7-37