CVP analysis examines how changes in cost and volume affect profit.
Important for planning and maximizing profit.
Sales mix defined as the proportion of various products sold.
Example of sales mix: 2,000 units sold with 1,500 camcorders (75%) and 500 TVs (25%).
Determining sales mix helps in calculating contribution margins for each product.
Contribution Margin: The selling price per unit minus variable costs per unit.
Weighted average unit contribution margin is calculated based on sales mix and individual contribution margins.
Need to analyze contribution margins for products when calculating breakeven point.
If camcorders have a contribution margin of $200 and TVs $500:
Weighted average contribution margin = $275 (weighted based on sales mix).
Example breakeven scenario:
Fixed costs of $275,000.
Breakeven units = Fixed Costs / Weighted Average Contribution Margin.
1,000 units at breakeven: 750 camcorders and 250 TVs.
Production often limited by factors like materials or machinery hours.
Decision making shifts to maximize contribution margin per limited resource.
Example: Camcorders (0.2 hours per unit) vs. TVs (0.625 hours per unit).
Camcorders generate $1,000 contribution margin per hour vs. TVs at $800.
Choose products to manufacture based on contribution margin per machine hour.
Theory of Constraints:
Always constraints limiting production; identify and manage them effectively.
Examines fixed versus variable cost structure and its impact on profitability.
Control over cost structure while planning:
Decisions on salaries versus commissions impact fixed/variable costs.
Comparing companies:
NewWave has higher fixed cost, leading to higher contribution margins per sales dollar compared to Vargo.
Higher fixed costs imply more risk with higher operating leverage.
NewWave requires $650,000 in sales to break even; Vargo only needs $500,000.
Margin of Safety Ratio:
Measures how sales can decline before hitting losses.
NewWave: 19% decline before loss; Vargo: 38% decline before loss.
Higher operating leverage means greater sensitivity in net income to changes in sales revenue.
Calculation of Operating Leverage = Contribution Margin / Net Income.
NewWave's earnings can fluctuate significantly with sales changes compared to more stable Vargo.
As sales increase, profits for firms with high operating leverage rise steeply and falls sharply when sales decrease.