Cost Volume Profit Analysis

Cost Volume Profit AnalysisCost Volume Profit Analysis

Introduction Introduction The Profit FunctionThe Profit FunctionBreakeven AnalysisBreakeven AnalysisDifferential Cost AnalysisDifferential Cost Analysis

IntroductionIntroduction

The Profit EquationThe Profit Equation

OperatingProfit

TotalRevenue

TotalCosts = –

Operating profit equals total revenue Operating profit equals total revenue less total costs.less total costs.

π = TR – TC

The Profit EquationThe Profit Equation

TotalRevenue

Average SellingPrice Per Unit

Units ofOutput

= ×

TR = P × Q

The Profit EquationThe Profit Equation

TotalCosts

Variable CostsPer Unit

Units ofOutput

= ×

TC = (V × Q) + F

FixedCosts+

The Profit EquationThe Profit Equation

Now, we’ll expand our Now, we’ll expand our original equation for profits!original equation for profits!

(P × Q) - [(V × Q) + F]=π

The Profit EquationThe Profit Equation

Now, we’ll expand our Now, we’ll expand our original equation for profits!original equation for profits!

(P × X) - [(V × X) + F]=

(P – V)Q – F=

ππ

ExampleExample

Here is the information from the Mr. X Bikes:

Total Per Unit PercentSales (500 bikes) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%

Less: fixed expenses 80,000 Net income 20,000$

Finding Target VolumesFinding Target Volumes

The formula to find a volume expressed in units for a target profit is . . .

TargetVolume(units)

=Fixed costs + Target profit

Contribution margin per unit

How many bikes must Mr X sell to earn an annual profit of $100,000?

Target Volume in Sales DollarsTarget Volume in Sales Dollars

The equation for finding the target volume in sales dollars is . . .

Fixed costs + Target profit Contribution margin ratioContribution margin ratio

TargetVolume(sales $)

=

Finding the Break-Even PointFinding the Break-Even Point

The Break-Even Point Break-Even Point is the volume level where profits equal zero.

� To find the break-even point in unitsunits, we use the target volume in units target volume in units equation and set the profit to zero.

� To find the break-even point in sales dollarssales dollars, we use the target volume in sales dollars target volume in sales dollars equation and set the profit to zero.

Break-Even in Units and dollarsBreak-Even in Units and dollars

Let’s use the Mr X Bikes information again.

Total Per Unit PercentSales (500 bikes) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%

Less: fixed expenses 80,000 Net income 20,000$

Contribution margin ratio

Contribution margin per unit

Break-Even in UnitsBreak-Even in Units

Break-EvenVolume(units)

=Fixed costs

Contribution margin per unit

= $80,000 200

= 400 units

Break-Even in Sales DollarsBreak-Even in Sales Dollars

= $200000

$80,000 .40

Fixed costs Contribution margin ratio

Break-EvenVolume(sales $)

=

=

Graphic PresentationGraphic PresentationConsider the following information for X Bikes:

Income 300 units

Income 400 units

Income 500 units

Sales 150,000$ 200,000$ 250,000$Less: variable expenses 90,000 120,000 150,000 Contribution margin 60,000$ 80,000$ 100,000$Less: fixed expenses 80,000 80,000 80,000 Net income (loss) (20,000)$ -$ 20,000$

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

- 100 200 300 400 500 600 700 800

Graphic PresentationGraphic Presentation

Volume per period (X)

Dol

lars

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

- 100 200 300 400 500 600 700 800

Graphic PresentationGraphic Presentation

Break-even point

Dol

lars

Volume per period (X)

Using CVP to Analyze Different Using CVP to Analyze Different Cost StructuresCost Structures

Operating leverageOperating leverage

Margin of safety Margin of safety

Operating leverageOperating leverage

Is a measure of how sensitive net operating income is to percentage change in sales.

Degree of Operating leverage Operating leverage = = Contribution margin

Net operating income

$100000 $20000

==

= 5= 5

Margin of SafetyMargin of SafetyExcess of projected (or actual) sales over the break-

even volume.The amount by which sales can fall before the company

is in the loss area of the break-even graph.

Sales Volume - Break even sales volumeSales Volume - Break even sales volume Margin of Safety =Margin of Safety =

= = $250000 - 250000 - Fixed costs Fixed costs

CM ratioCM ratio= $250000 - = $250000 - $80000 $80000

.4.4

= $50000 = $50000

Thanks