11. Cost-volume profit analysis

What is Topic 11 mainly about?

Cost-volume-profit analysis.

What is cost-volume-profit analysis?

Analysis of how costs, sales volume and profit are related.

Why is CVP useful in business planning?

It helps determine whether a product or service is viable before starting or expanding.

What is break-even point?

The level of sales where total revenue equals total costs, so there is no profit or loss.

Why is break-even useful?

It shows the minimum sales needed to cover all costs.

What happens after the break-even point is reached?

Each additional unit sold contributes to profit.

What is contribution margin per unit?

Selling price per unit minus variable cost per unit.

What is the contribution margin formula?

Contribution Margin = Selling Price per Unit - Variable Cost per Unit.

What is the break-even formula in units?

Break-even units = Fixed Costs / Contribution Margin per Unit.

What is the target profit formula?

Units required = (Fixed Costs + Target Profit) / Contribution Margin per Unit.

Why must break-even units be rounded up?

Because a business cannot usually sell part of a unit, and rounding down means it has not truly broken even.

What are fixed costs?

Costs that stay the same in total within the relevant range, regardless of activity level.

Give examples of fixed costs.

Rent, insurance, salaries, advertising and depreciation.

How do fixed costs behave per unit?

Fixed cost per unit decreases as activity increases.

What are variable costs?

Costs that change in total in direct proportion to activity level.

Give examples of variable costs.

Direct materials, fuel per job, packaging and sales commissions.

How do variable costs behave per unit?

Variable cost per unit stays the same within the relevant range.

What are mixed costs?

Costs that have both fixed and variable components.

Give an example of a mixed cost.

A phone bill with a monthly base fee plus extra charges based on usage.

What is relevant range?

The activity range where cost behaviour assumptions are expected to remain valid.

Why is relevant range important?

Outside the relevant range, fixed and variable costs may not behave as expected.

What could a manager do if break-even is too high?

Reduce fixed costs, reduce variable costs, increase selling price, or reconsider the business idea.

Why might fixed costs increase when expanding?

The business may need more equipment, staff, rent space or infrastructure.

What is the main exam tip for Topic 11?

Know contribution margin, break-even, target profit, cost behaviour and always round break-even units up.