0. Cost-Volume-Profit Analysis
CHAPTER 7
Cost-Volume-Profit Analysis
© 2009 Cengage Learning

1. Introduction
Cost-volume-profit (CVP) analysis focuses on the following factors:
The prices of products or services
The volume of products or services produced and sold
The per-unit variable costs
The total fixed costs
The mix of products or services produced

2. The Contribution Margin Income Statement
The contribution margin income statement is structured by behavior rather than by function.
Sales - All Variable Costs = Contribution Margin
Contribution Margin - All Fixed Costs = Net Income

3. Income Statements TRADITIONAL CONTRIBUTION MARGIN Sales
Less: Cost of Goods Sold:
Variable Costs
Fixed Costs
Total Cost of Goods Sold
Gross Profit
Less: S, G, & A Costs:
Total S, G, & A Costs
Net Income
$1,000
350
150
$ 500
$ 50
250
$ 300
$ 200
Sales
Less: Variable Costs:
Manuf. Costs
S, G, & A Costs
Total Variable Costs
Contribution Margin
Less: Fixed Costs:
Total Fixed Costs
Net Income
$1,000
$350 50
$400
$600
$150
250
$200

4. The Contribution Margin Income Statement
Key Concept
The contribution margin income statement is structured to emphasize cost behavior as opposed to cost function.

5. Contribution Margin Per Unit
Sales (100,000 units)
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Net Income
Total
$200,000
80,000
$120,000
40,000
$80,000
Per Unit
$2.00
.80
$1.20

6. Contribution Margin Per Unit
What if Cheri’s Chips sold one more unit?
Total
$200,002.00
80,000.80
$120,001.20
40,000.00
$80,001.20
Per Unit
$2.00
.80
$1.20
Sales (100,001 units)
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Net Income

7. Contribution Margin Per Unit
Key Concept
For every unit change in sales, contribution margin will increase or decrease by the contribution margin per unit multiplied by the increase or decrease in sales volume.

8. Contribution Margin Ratio
Is equal to
Contribution Margin (in $)
Sales (in $)

9. Contribution Margin Ratio
Sales (100,000 units)
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Net Income
Total
$200,000
80,000
$120,000
40,000
$80,000
Percent
100% 40
60%
$120,000
$200,000

10. Contribution Margin Ratio
Key Concept
The contribution margin per unit and the contribution margin ratio will remain constant as long as sales vary in direct proportion with volume.

11. Contribution Margin Ratio
Key Concept
For every dollar change in sales, contribution margin will increase or decrease by the contribution margin ratio multiplied by the increase or decrease in sales dollars.

12. The Contribution Margin and Its Uses
What would happen if sales increase?
Use the CM to determine the increase in net income. Then consider options to increase sales.
Lower sales price?
Increase incentives for sales staff?
Improve quality of product?
Increase advertising budget?

13. Option 1: Reduce variable costs.
Decisions Using CVP
Option 1: Reduce variable costs.
When variable costs are reduced, contribution margin will increase. Options?
Find less expensive supplier of raw material
Reduce the amount of labor used
Use lower-wage employees
What would be the consequences of each?

14. Decisions Using CVP Lower Variable Costs by $7,200 Sales
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Net Income (Loss)
Current
$200,000
80,000
$120,000
40,000
$80,000
Option 1
$200,000
72,800
$127,200
40,000
$87,200

15. Decisions Using CVP Option 2: Change incentive structure
Raise sales commissions on all sales above the present level by 10 percent. Sales will increase by $30,000 or 15,000 bags. Additional sales commission will be $3,000.

16. Impact of increasing Sales Incentives, Sales = $230,000
Decisions Using CVP
Impact of increasing Sales Incentives, Sales = $230,000
Sales
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Net Income (Loss)
Total
$200,000
80,000
$120,000
40,000
$80,000
Option 2
$230,000
95,000
$135,000
40,000
$95,000
Variable Costs: 230,000*.40% + $3,000

17. Decisions Using CVP Option 3: Increase Advertising
Spending an additional $10,000 on advertising will increase sales by $40,000 or 20,000 bags.

18. Decisions Using CVP Impact of increasing advertising: Sales = $140,000
Current
$200,000
80,000
$ 120,000
40,000
$ 80,000
Option 3
$240,000
96,000
$ 144,000
50,000
$ 94,000
Sales
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Net Income (Loss)

19. Changes in Price and Volume
If the manager changes the sales price resulting in a change in sales volume, what will be the impact on net income?
Raising the sales price may decrease sales volume but the impact on total sales revenue may be offset by the increase in sales price.
Decreasing the sales price may increase the sales volume without increasing total sales revenue.

20. Changes in Price and Volume
These business decisions involve individuals in many areas of an organization, such as marketing, sales, production management, and even human resources personnel for hiring decisions. The implications of a bad decision in this area can affect the firm’s bottom line.

21. Changes in Cost, Price, and Volume
Changes can be made to cost, price, and volume at the same time.
Changes in one variable almost always impact one or both of the other variables.

22. Break-Even Analysis
Break-Even Point: The level of sales where contribution margin just covers fixed costs and consequently net income is equal to zero.

23. Contribution Margin Per Unit Contribution Margin Ratio
Break-Even Analysis
Break-Even (units)
Fixed Costs
Contribution Margin Per Unit =
Break-Even (Sales $)
Fixed Costs
Contribution Margin Ratio =

24. Break-Even Graph $ Volume Revenue Break-Even Point Profit Area
Total Cost
Break-Even
Point
in $
Break-Even Point in Volume
Volume
Loss Area

25. Break-Even Calculations with Multiple Products
The calculation of “average” contribution margin is really a weighted average.
Fixed Costs
Weighted Average Contribution Margin Per Unit
Break-Even (Units) =

26. Break-Even Calculations Using Activity-Based Costing
When using activity-based-costing, costs are classified as unit, batch, product, or facility level instead of variable or fixed.
Break-Even (units) =
Fixed Costs + Batch-Level Costs + Product-Level Costs
Contribution Margin Per Unit

27. Target Profit Analysis (Before and After Tax)
To determine the sales units required to achieve a target profit before taxes:
Sales Volume =
Fixed Costs + Target Profit (before taxes)
Contribution Margin Per Unit

28. Target Profit Analysis (Before and After Tax)
Multiple product formula to reach a target profit:
Sales Volume =
Fixed Costs + Target Profit
Weighted-Average Contribution Margin Per Unit

29. Target Profit Analysis (Before and After Tax)
ABC formula to reach a target profit:
Sales (units) =
Fixed Costs + Batch-Level Costs + Product-Level Costs + Target Profit
Weighted-Average Contribution Margin Per Unit

30. The Impact of Taxes If
After-Tax Profit = Before-Tax Profit (1-tax rate)
then
Before-Tax Profit = After-Tax Profit / (1-tax rate)
Therefore, to determine after-tax Target Profit
Fixed Costs + After-Tax Profit / (1-Tax Rate)
Contribution Margin per Unit
Sales in units =

31. The Impact of Taxes Key Concept
The payment of income tax is an important variable in target profit and other CVP decisions.

32. Assumptions of CVP Analysis
Selling price is constant throughout the relevant range.
Costs are linear throughout the relevant range.
The sales mix used to calculate the weighted average contribution margin is constant.
The amount of inventory is constant.

33. Cost Structure and Operating Leverage
Operating Leverage: The measure of the proportion of fixed costs in a company’s cost structure. It is used as an indicator of how sensitive profit is to changes in sales volume.

34. Cost Structure and Operating Leverage
Contribution Margin
Net Income
Operating Leverage =
Operating Leverage X % Increase in Sales = % Increase in Net Income

35. Cost Structure and Operating Leverage
Company B 500 1,000 2,000
Sales
Cont. Margin
Net Income
$100,000
$ 60,000
$ 20,000
$200,000
$120,000
$ 80,000
$400,000
$240,000
$200,000
Operating Leverage
$60,000 $20,000
$120,000 $80,000
$240,000 $200,000
10% Increase in Sales 30% 15% 12%

36. Cost Structure and Operating Leverage
Key Concept
A company operating near the break-even point will have a high level of operating leverage and income will be very sensitive to changes in sales volume.