# The Basics of Cost-Volume-Profit (CVP) Analysis Contribution margin (CM) is the difference between sales revenue and variable expenses. Next Page Click.

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The Basics of Cost-Volume-Profit (CVP) Analysis Contribution margin (CM) is the difference between sales revenue and variable expenses. Next Page Click Here CM can be expressed in total or per unit. The CM ratio is computed by dividing the per unit contribution margin by the per unit selling price. \$200 ÷ \$500 = 40%

The Basics of Cost-Volume-Profit (CVP) Analysis After fixed expenses are covered, any additional contribution margin results in net income. Next Page Click Here

Break-Even Point Wind has \$80,000 of fixed expenses. If Wind sells 400 units in a month, Wind will generate \$80,000 in total CM (\$200 CM per unit x 400 units). Wind will be operating at its break-even point. Next Page Click Here

Additional Unit Sales If Wind sells one additional unit (that is, 401 bikes), net income will be \$200. Net income will increase by \$200 (the CM per unit) as each additional unit is sold. Next Page Click Here

The Contribution Approach  The point where total contribution margin equals total fixed expenses. Ë The point where total sales revenue equals total expenses (variable and fixed). The break-even point can be defined as: Next Page Click Here Break-even analysis can be approached in two ways - contribution margin method or equation method. Covered here

Break-Even Analysis Fixed expenses (costs) total \$80,000. Bikes sell for \$500 per unit; variable expenses are \$300 per unit. CM = \$500 - \$300 = \$200 per unit CM Ratio = \$200 ÷ \$500 = 40% Fixed costs Unit contribution margin = Break-even point in units sold Fixed costs CM ratio = Break-even point in total sales dollars Next Page Click Here \$80,000 \$200 = Break-even point in units sold \$80,000 40% = Break-even point in total sales dollars = 400 units = \$200,000

CVP Relationships in Graphic Form Viewing CVP relationships in a graph gives managers a perspective that can be obtained in no other way. Consider the following information for Wind Company: Next Page Click Here

Units Dollars CVP Graph Break-even point Profit Area Loss Area Total Expenses Total Sales Fixed Expenses Next Page Click Here

Target Income Analysis Fixed costs total \$80,000. Bikes sell for \$500 per unit; variable expenses are \$300 per unit. Target after-tax income is \$45,000; tax rate is 25%. CM = \$500 - \$300 = \$200 per unit CM Ratio = \$200 ÷ \$500 = 40% Before tax income = \$45,000 ÷ (1 -.25) = \$60,000, so tax expense = \$60,000 - \$45,000 = \$15,000 Target Fixed After-Tax Income costs Income Taxes CM per unit = Unit sales at target after-tax income Next Page Click Here = ++ \$80,000 + 45,000 + \$15,000 \$200 \$140,000 \$200 = 700 units

Target Income Analysis Fixed costs total \$80,000. Bikes sell for \$500 per unit; variable expenses are \$300 per unit. Target after-tax income is \$45,000; tax rate is 25%. CM = \$500 - \$300 = \$200 per unit CM Ratio = \$200 ÷ \$500 = 40% Before tax income = \$45,000 ÷ (1 -.25) = \$60,000, so tax expense = \$60,000 - \$45,000 = \$15,000 Target Fixed After-Tax Income costs Income Taxes CM Ratio = Dollar sales at target after-tax income Next Page Click Here = ++ \$80,000 + 45,000 + \$15,000 40% \$140,000 40% = \$350,000

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