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Chapter 6
McGraw-Hill/Irwin
Cost-Volume-Profit Analysis
A powerful tool that helps managers understand the relationships among cost, volume, and profit. CVP analysis focuses on how profits are affected by the following five factors: 1. Selling Prices 2. Sales Volume 3. Unit variable costs 4. Total fixed costs 5. Mix of products sold. Decisions: what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to implement.
CM is used first to cover fixed expenses. Any remaining CM contributes to net operating income.
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$0 = $200 Q + $80,000
Profits are zero at the break-even point. CM=Fixed Costs CM-Fixed costs= 0 Profit
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The Contribution Approach If RBC sells 400 units in a month, it will be operating at the break-even point.
Racing Bicycle Company Contribution Income Statement For the Month of June Total Per Unit Sales (400 bicycles) $ 200,000 $ 500 Less: Variable expenses 120,000 300 Contribution margin 80,000 $ 200 Less: Fixed expenses 80,000 Net operating income $ -
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Profit = (P Q V Q) Fixed expenses Profit = (P V) Q Fixed expenses Profit = Unit CM Q Fixed expenses
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Quantity sold (Q) Variable expenses per unit (V) = Variable expenses (Q V)
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$300,000
Profit Area
$250,000
$200,000
Fixed expenses
$100,000
$50,000
$0
100
200
300
400
500
600
Loss Area
Units
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$0 -$20,000 -$40,000 -$60,000 0 100 200 300 400 Number of bicycles sold
An even simpler form of the CVP graph is called the profit graph.
500 600
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$0 -$20,000 -$40,000 -$60,000 0 100 200 300 400 Number of bicycles sold 500 600
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Target Profit Analysis in Terms of Unit Sales Suppose Racing Bicycle Company wants to know how many bikes must be sold to earn a profit of $100,000.
Unit sales to attain Target profit + Fixed expenses = the target profit CM per unit
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Formula Method
We can calculate the dollar sales needed to attain a target profit (net operating profit) of $100,000 at Racing Bicycle.
Dollar sales to attain Target profit + Fixed expenses = the target profit CM ratio
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Assuming the target profit is P6,500 AFTER INCOME TAXES OF 35% for Racing Company, how much should sales (units and peso) to be able to reach the target profit? (Fixed costs= P20,000, CM/u= P1, SP/u= P4)
Sales volume with desired profit P 20,000 after income tax = Sales volume Peso Sales P 6,500 ( 1 35% ) P1 = 30,000 UNITS =30,000 units x P4/u =P120,000
The Margin of Safety in Dollars The amount by which sales can drop before losses are incurred.
Margin of safety in dollars = Total sales - Break-even sales
Lets look at Racing Bicycle Company and determine the margin of safety. MOS= $250,000- $200,000=$50,000 MOS%= $50,000/$250,000= 20%
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Operating Leverage
Operating leverage is a measure of how sensitive net operating income is to percentage changes in sales. It is a measure, at any given level of sales, of how a percentage change in sales volume will affect profits. Degree of operating leverage Contribution margin = Net operating income
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10% increase on sales: EFFECT IN NET OPERATING INCOME? 70% increase in the net operating income. HIGHER OPERATING LEVERAGE.
10% increase on sales: EFFECT IN NET OPERATING INCOME? 40% increase in the net operating income. LOWER OPERATING LEVERAGE.
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End of Chapter 6
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