Cost-Volume-Profit Analysis

Flashcards based on CVP analysis lecture notes.

Cost-Volume-Profit (CVP) Analysis

The study of the effects of changes in costs and volume on a company's profits. It is important in profit planning. It is useful in settling selling prices, determining product mix, and maximizing use of production facilities.

CVP analysis considers the interrelationships among the following component

• Volume or level of activity

• Unit selling prices

• Variable cost per unit

• Total fixed costs

• Sales mix.

The following assumptions underline each CVP analysis

• The behavior of both costs and revenues is linear throughout the relevant range of the activity index

• Costs can be classified accurately as either variable or fixed

• Changes in activity are the only factors that affect costs

• All units produced are sold

• When more than one type of product is sold, the sales mix will remain constant. (The percentage that each product represents of total sales will stay the same).

Contribution Margin

The amount of revenue remaining after deducting variable costs. It can be expressed as a per unit amount or as a ratio

Contribution Margin per Unit formula

Unit Selling Price – Unit Variable Costs.

Contribution Margin Ratio formula

Contribution Margin per Unit ÷ Unit Selling Price

Contribution margin ÷ Sales

Break-even Point

The company will realize no income but will suffer no loss. Useful to management when it decides whether to introduce new product lines, change sales price on established products, or enter new market areas.

Break-even Point in Units formula

Fixed Costs ÷ Contribution Margin per Unit

Fixed Costs / (Unit selling price - Unit variable cost)

Break-even Point in Peso formula

Fixed Costs ÷ Contribution Margin Ratio

Total Variable Cost + Total Fixed Cost

Required Sales in peso formula

(Fixed Costs + Target Net Income) ÷ Contribution Margin Ratio

Required Sales formula

Variable Costs + Fixed Costs + Target Net Income.

Margin of Safety

The difference between actual sales and break-even sales; indicates the maximum amount by which sales could decline without incurring a loss.

Sales Mix

The relative proportion in which each product is sold when a company sells more than one product. It is important to managers because different products often have substantially different contribution margins and break-even points.

BEP Units (multiple products) formula

Fixed Costs / Weighted Average CM per unit

BEP Peso Sales (multiple products) formula

Fixed Costs / Weighted Average CM Ratio

Degree of Operating Leverage (DOL) formula

Contribution Margin ÷ Profit before tax

Sensitivity Analysis

A 'what if' technique that examines the impact of changes on any variables. For example, changes in prices, variable costs, and fixed costs on expected profits.

Target income

The income objective set by management.

CVP income statement

Classifies costs and expenses as variable or fixed. It also reports contribution magin in the body of the statement.

Break-even sales in units

Can be computed for a mix of two or more products by determining the weighted-average unit contribution margin of all the products. Computed by dividing fixed costs by the weighted-average unit contribution margin.

Weighted-average unit contribution margin

Computed by adding the products of Product A’s unit contribution margin x its percentage of sales and Product B’s unit contribution margin x its percentage of sales.

Break-even point in peso

Computed by dividing fixed costs by the weighted-average contribution margin ratio.

Weighted-average contribution margin ratio

Computed by adding the products of Division A’s contrbution margin ratio x its percentage of sales and Division B’s contribution margin ratio x its percentage of sales

Degree of operating leverage (DOL)

Provides a measure of a company’s earnings volatility and can be used to compare companies. Computed by dividing total contribution margin by net income

Unit sales with target profit formula

(Fixed costs + Profit) ÷ Contribution margin per unit

Peso sales with Target return on sales formula

Fixed Costs ÷ (CM ratio - Return on Sales)

Profit must be expressed before tax formula

Profit after tax ÷ (100% - tax rate)

Margin of safety formula

Sales - Break-even sales

Margin of safety ratio formula

Margin of safety ÷ Sales

Change in % profit before tax is equal to

Change in % sales x Degree of operating leverage