0 chapter 7 cost-volume-profit analysis © 2009 cengage learning
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CHAPTER 7
Cost-Volume-Profit Analysis
© 2009 Cengage Learning
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Introduction
Cost-volume-profit (CVP) analysis focuses on the following factors:
1. The prices of products or services
2. The volume of products or services produced and sold
3. The per-unit variable costs
4. The total fixed costs
5. The mix of products or services produced
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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
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Income Statements
TRADITIONAL CONTRIBUTION MARGIN
Sales Less:
Cost of Goods Sold:
Variable CostsFixed Costs
Total Cost of Goods SoldGross ProfitLess: S, G, & A Costs:
Variable CostsFixed Costs
Total S, G, & A CostsNet Income
SalesLess: Variable Costs:
Manuf. CostsS, G, & A Costs
Total Variable CostsContribution MarginLess: Fixed Costs:
Manuf. CostsS, G, & A Costs
Total Fixed CostsNet Income
$1,000
350150
$ 500
$ 500
$ 50250
$ 300
$ 200
$1,000
$35050
$400$600
$150250
$400$200
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The Contribution Margin Income Statement
The contribution margin income statement is
structured to emphasize cost behavior as opposed to cost
function.
Key Concept
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Contribution Margin Per Unit
Sales (100,000 units) Less: Variable Costs Contribution MarginLess: Fixed CostsNet Income
Total
$200,00080,000
$120,00040,000
$80,000
Per Unit
$2.00.80
$1.20
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Contribution Margin Per Unit
Sales (100,001 units) Less: Variable Costs Contribution MarginLess: Fixed CostsNet Income
Total
$200,002.0080,000.80
$120,001.2040,000.00
$80,001.20
Per Unit
$2.00.80
$1.20
What if Cheri’s Chips sold one more unit?
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Contribution Margin Per Unit
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.
Key Concept
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Contribution Margin Ratio
Contribution Margin Ratio
Is equal to
Contribution Margin (in $)
Sales (in $)
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Contribution Margin Ratio
Sales (100,000 units) Less: Variable Costs Contribution MarginLess: Fixed CostsNet Income
Total
$200,00080,000
$120,00040,000
$80,000
Percent
100%40 60%
$120,000$200,000
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Contribution Margin Ratio
The contribution margin per unit and the contribution margin ratio will remain constant as long as sales vary in direct proportion with volume.
Key Concept
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Contribution Margin Ratio
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.
Key Concept
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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?
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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?
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Decisions Using CVP
SalesLess: Variable Costs Contribution MarginLess: Fixed CostsNet Income (Loss)
Current
$200,00080,000
$120,00040,000
$80,000
Option 1
$200,00072,800
$127,20040,000
$87,200
Lower Variable Costs by $7,200
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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.
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Decisions Using CVP
Impact of increasing Sales Incentives, Sales = $230,000
SalesLess: Variable Costs Contribution MarginLess: Fixed CostsNet 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
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Decisions Using CVP
Option 3: Increase Advertising
Spending an additional $10,000 on advertising will increase sales by $40,000 or 20,000 bags.
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Decisions Using CVP
Impact of increasing advertising: Sales = $140,000
SalesLess: Variable Costs Contribution MarginLess: Fixed CostsNet Income (Loss)
Current
$200,000 80,000$ 120,000 40,000$ 80,000
Option 3
$240,000 96,000$ 144,000 50,000$ 94,000
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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.
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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.
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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.
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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.
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Break-Even Analysis
Fixed Costs Contribution Margin Per Unit
Break-Even (Sales $)
Break-Even
(units)
=
Fixed CostsContribution Margin Ratio=
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Break-Even Graph
Volume
$Revenue
Total Cost
Break-Even Point
Break-Even Point in VolumeBreak-EvenPointin $
Loss Area
Profit Area
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Break-Even Calculations with Multiple Products
The calculation of “average” contribution margin is really a weighted average.
Break-Even (Units) =
Fixed Costs
Weighted Average Contribution Margin
Per Unit
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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
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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
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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
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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
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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
Sales in units =
Fixed Costs + After-Tax Profit / (1-Tax Rate)
Contribution Margin per Unit
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The Impact of Taxes
The payment of income tax is an
important variable in target profit and other
CVP decisions.
Key Concept
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Assumptions of CVP Analysis
1. Selling price is constant throughout the relevant range.
2. Costs are linear throughout the relevant range.
3. The sales mix used to calculate the weighted average contribution margin is constant.
4. The amount of inventory is constant.
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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.
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Cost Structure and Operating Leverage
Operating Leverage =
Contribution Margin
Net Income
Operating Leverage X % Increase in Sales = % Increase in Net Income
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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
3.0 1.5 1.2
10% Increase in Sales30% 15% 12%
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Cost Structure and Operating Leverage
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.
Key Concept