Module 13, Cost-Volume-Profit Analysis

Contribution Margin

The amount by which a product’s selling price exceeds its total variable cost.

• Calculated by “sales - variable cost”, or “(total sales)(contribution margin ratio)”.

Contribution Margin per Unit

Is useful to management because it is the per unit contribution toward covering fixed costs.

• Calculated by “sales price per unit - variable cost per unit”.

Contribution Margin Ratio

The percentage of revenue remaining after subtracting variable costs.

• Calculated by “contribution margin per unit / sales price per unit“.

• e.g., A value of 0.80 means that $0.80 of every sales dollar goes toward meeting fixed costs, and once those are met, $0.80 of every sales dollar will go toward profit.

Contribution Margin Format Income Statement

An income statement that separates variable costs from fixed costs.

• Useful tool for analyzing the effect of changes in sales price, variable costs, or fixed costs.

Number of Units Sold via Contribution Margin

Calculated by “total contribution margin / contribution margin per unit”.

Break-Even Point

The sales level at which a company's total revenue equals its total costs, resulting in zero profit or loss.

• i.e., “Sales - total cost = 0”, “sales = total cost”, or “sales - fixed costs - variable costs = 0”.

• Can be found using the contribution margin.

  • In units, it can be calculated by “total fixed costs / contribution margin per unit”.

  • In sales dollars, it can be calculated by “fixed costs / contribution margin ratio”.

• Is a useful tool for management to assess the impact on the company of changes in selling price, sales volume, fixed costs, or variable costs.

Units Sold to Attain Profit

Used to determine the amount of units that would need to be sold that would be needed to generate a desired profit.

• Calculated by “(fixed costs + target profit) / contribution margin per unit”.

Sales Dollars to Attain Target Profit

Used to determine the level of sales dollars that would be needed to generate a desired profit.

• Calculated by “(fixed costs + target profit) / contribution margin ratio”.

With an increase in selling price, it takes _____ units to break-even because of the _____ in the contribution margin.

Fewer; increase.

With an increase in variable cost, it takes _____ units to break-even because of the _____ in the contribution margin.

More; decrease.

An increase in fixed cost _____ the contribution margin, but it will mean that _____ units are needed to break-even.

Does not change; more.

A decrease in variable cost alone would _____ the break-even point, and an increase in fixed costs alone would _____ the break-even point; therefore, when two variables change, what happens to break-even depends on _____.

Decrease; increase; the amount of change of each of the variables.

Margin of Safety

The difference between a company’s current sales and its break-even sales.

• Shows how much a company can lose in sales before the company falls below the break-even point.

  • i.e., “How much can sales drop before we are in a “loss” position?”.

• In sales dollars, it is calculated by “total budgeted (or actual sales) - break-even sales”.

Operating Leverage

A measurement of how sensitive operating income is to a percentage change in sales dollars.

• Typically, the higher the level of fixed costs, the higher the level of risk.

• As sales volumes increase, the payoff is typically greater with higher fixed costs than with higher variable costs.

• In other words, the higher the risk, the greater the payoff (as long as you are operating above the break-even point). The higher the risk, and greater the loss if you are operating below the break-even point.

Degree of Operating Leverage

Calculated by “contribution margin / net operating income”.

Operating leverage has a multiplier effect, which means that…

A change in an input (such as variable cost per unit) by a certain percentage has a greater effect (a higher percentage effect) on the output (such as net income).

• Therefore, if this value is high, then a very small increase in sales can result in a large increase in net operating income.

Percentage Change in Net Operating Income

Calculated by “(degree of operating leverage)(percentage change in sales)”.