4 WHAT DOES IT MEAN TO “BREAK EVEN” Total revenues = total expensesProfit = $0There is one sales volume at which this relationship is trueThis is called the “breakeven point”
5 TO CALCULATE THE BREAKEVEN POINT Use the equation approachSales Revenue– Variable expenses– Fixed expenses= Operating income(SP×units sold) – (VC×units sold) – FC = $0[(SP – VC)×(units sold)] – FC = $0(CM/unit×units sold) – FC = $0Solve for units sold, which equals the breakeven pointWhy is profit set to $0?
12 LET’S REVIEW THE PROFIT EQUATION SP×(units sold)– VC×(units sold)– FC= OI
13 HOW MUCH DO I HAVE TO SELL TO MAKE $X? This is called the “target income” questionUse the profit equationUse the breakeven formula and treat your target pretax income as additional fixed costs(SP×units sold) – (VC×units sold) – FC = $XFC + Target IncomeCM / unit= required sales volumeTo find the sales dollars required to attain the target income, use the CMR rather than the CM / unit.
14 WHAT ABOUT TARGET NET INCOME? You must adjust net income to pretax incomeDivide target net income by (1 - tax rate)Solve as beforeTotal FC += required sales volumeCM / unitTarget net income1 – tax rate
15 CVP ANALYSIS Stands for cost-volume-profit A tool to determine the impact of changes in sales volume, costs, or sales mix on net incomeUseful for evaluating decision alternatives
16 THREE APPROACHES TO CVP Prepare a contribution format income statement before and after implementing the changesPrepare a partial contribution format income statement that includes only those items that change (called the “incremental approach”)Compare the current total contribution margin with the proposed total contribution margin, then adjust for changes in fixed expenses
17 CVP AND THE SUPPLY CHAIN How do the CVP decisions of supply chain partners affect each other?For example, consider the jerseys that Universal Sports Exchange purchases from C&C Sports.What happens if C&C Sports increases the selling price?What happens if Universal Sports Exchange decides to use a cheaper supplier?
18 OPERATING LEVERAGEFirms sometimes have the option to trade fixed costs for variable costsHigher levels of fixed costs introduce higher levels of riskMeasures the magnitude of change in operating income for a given percentage change in sales revenueDegree of operating leverage =Contribution marginNet operating income
19 WHY DO WE CARE ABOUT OPERATING LEVERAGE? Exhibit 3-4
21 MULTIPRODUCT CVP Rarely does a company produce a single product Since not every product will have the same contribution margin, we have a problem when more than one product is produced
22 WHAT IS “SALES MIX”? The “bag” or “package” of goods sold For example: For every dining room table sold, the company also sells 4 chairsFor every computer sold, the company also sells a monitor and a printerFor every pair of athletic shoes sold, Landon Sports sells 4 baseball jerseys
23 USE THE PROFIT EQUATION…WITH ADJUSTMENTS ProductPriceVariable CostContribution MarginJerseys$20$16.00$4.00Shoes$45$38.70$6.30CM(jerseys) + CM(shoes) – FC = OI
24 DETERMINE THE SALES MIX ProductContribution MarginSales MixAdjusted Contribution MarginJerseys$4.004x$16.00xShoes$6.301x$ 6.30xJerseysShoes41:$4.00(4x) + $6.30(x) – FC = OI$16x + $6.30x – FC = OI
26 LIMITING ASSUMPTIONS OF CVP ANALYSIS All costs can be divided into fixed and variable componentsAll cost and profit functions are linear throughout the relevant rangeSales mix will remain constant
27 CHANGES EXAMINED USING CVP Change in sales priceChange in sales volumeChange in variable costs per unitChange in fixed costsChange in sales mixAny combination of the aboveRemember to always use “constant” forms – SP/unit, VC/unit, Total FC – when doing CVP analysis
33 ISSUES WITH COST-PLUS PRICING What if customers are willing to pay more than the calculated price?Cost-plus pricing does not recognize the value provided to the customer; it recognizes a return to the sellerThe costs of the seller’s inefficiencies are borne by the customers
34 TARGET COSTING Start with an estimate of the price customers will pay Subtract the desired markupThe result is the target, or maximum, product costThis is calculated before the product is designed and manufacturedIf you can produce the product for the target cost, go forward