Cost-Volume-Profit Analysis

Cost-Volume-Profit Analysis

1. Cost Behavior: Manner in which a cost changes as a related activity changes

   • Variable Costs
     • Costs that vary in proportion to changes in the activity base
       • Cost/unit
         • Remains the same regardless of changes in the activity base
       • Total cost
         • Changes in proportion to changes in the activity base
   • Fixed Costs
     • Costs that remain the same in total dollar amount as the activity base changes
       • Cost/unit
         • Decreases as the activity level increases & vise versa
       • Total cost
         • Remains the same regardless of changes in the activity base
   • Mixed Costs
     • Characteristics from variable & fixed costs (semivariable/ semifixed)
       • Contain a fixed cost component that is incurred even if there is no production

2. Cost-Volume-Profit Relationships

   • Contribution Margin
   • Contribution Margin Ratio
   • Contribution Margin: the excess of sales over variable cost
     • Provides insight into the profit potential of a company
     • = Sales - Variable Cost
   • Contribution Margin Ratio (Profit-Volume Ratio)
     • Indicates the % of each sales dollar available to cover fixed costs & to provide income from operations
     • = Contribution Margin/ Sales OR = Unit Contribution Margin/ Unit Selling Price
     • Change in Income from Operations = Change in Sales Dollars * Contribution Margin Ratio
   • Unit Contribution Margin
     • Useful for analyzing the profit potential of proposed decisions
     • = Sales Price/Unit - Variable Cost/Unit
     • Change in Income from Operations: Change in Sales Units * Unit Contribution Margin

3. Cost-Volume-Profit Analysis

   • Break Even Point
     • Revenue = Costs
       • Sales Units
         • Fixed Costs / Unit Contribution Margin
       • Sales Dollars
         • Fixed Costs / Contribution Margin Ratio
     • If FIXED COSTS rise, then BREAK EVEN rises & Vise Versa
       • If UNIT VARIABLE COST rises, then BREAK EVEN rises & Vise Versa
       • If UNIT SELLING PRICE rises, BREAK EVEN decreases & Vise Versa
   • Target Profit
     • Sales (units) = (Fixed Costs + Target Profit) / Unit Contribution Margin
   • Cost-Volume-Profit Chart (Break-Even Chart)
     • Graphically shows sales, costs & related profit or loss for different levels of units sold
     • To elaborate
   • Profit Volume Chart
     • Only shows difference between Total Sales & Total Costs

4. Special Relationships & Analyses

   • Sales Mix
     • The relative distribution of sales among the products sold by a company
     • For Break Even Analysis
       • Products A&B= Product E
       • Unit Selling Price (E) = Unit Selling Prices * Sales Mix %
       • Unit Variable Cost & Unit Contribution Margin (E) = (Unit Variable Costs + Unit Contribution Margins) * Sales Mix %
       • Beak-Even Sales (units) of E = Fixed Costs / Unit Contribution Margin
   • Operating Leverage
     • = Contribution Margin / Income from Operations
     • Percent Change in Income from Operations = % Change in Sales * Operating Leverage
     • If OPERATING LEVERAGE is high, % IMPACT ON INCOME FROM OPERATIONS FROM A CHANGE IN SALES results large
     • If OPERATING LEVERAGE is low, % IMPACT ON INCOME FROM OPERATIONS FROM A CHANGE IN SALES results small
   • Margin of Safety
     • Indicates the possible decrease in sales that may occur before an operating loss results
     • It may be expressed as:
       • Dollars of Sales, Units of Sales or % of Current Sales
     • = (Sales - Sales @Break-Even Point) / Sales

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