Copyright 2010 Pearson Education Inc Publishing as Prentice
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 1
Cost-Volume-Profit Analysis Chapter 7 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 2
Learning Objective 1 Calculate the unit contribution margin and the contribution margin ratio Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 3
Cost-Volume-Profit (CVP) Analysis • Is a powerful tool that helps managers make important business decisions • Is a relationship among costs, volume, and profit or loss • Determines how much the company must sell each month just to cover costs or to break even • Helps managers decide how sales volume would need to change to achieve the same profit level Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 4
Components of CVP Analysis • CVP analysis relies on the interdependency of five components or pieces of information – Sales price per unit – Volume sold – Variable costs per unit – Fixed costs – Operating income • If you know or can estimate four of these five components, you can compute the remaining unknown amount Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 5
CVP Assumptions 1. Change in volume is only factor that affects costs 2. Managers can classify each cost as either variable or fixed • These costs are linear throughout relevant range 3. Revenues are linear throughout relevant range 4. Inventory levels will not change 5. The sales mix of products will not change Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 6
CVP Example Facts: Kay’s Posters Kay has an e-tail poster business. She currently sells each poster for $35, while each poster has a variable cost of $21. Kay has fixed costs of $7, 000. Kay is currently selling 550 posters. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 7
Contribution Margin Income Statement Kay’s e-tail poster example from prior slide Sales revenue (550 posters). . . . . $ 19, 250 Less: Variable expenses. . . (11, 550) Contribution margin. . . 7, 700 Less: Fixed expenses. . . (7, 000) Operating income. . . . $ 700 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8
Unit Contribution Margin Kay’s e-tail poster example from previous slides Sales price per unit - Variable costs per unit Contribution margin per unit $ 35 (21) $ 14 Now assume sales are 650 units: Contribution margin ( 650 sales X $14) - Fixed cost Operating Income $ 9, 100 (7, 000) $ 2, 100 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 9
Contribution Margin Ratio Contribution margin ratio = percentage of each sales dollar that is available for covering fixed expenses and generating a profit. Contribution margin ratio Unit contribution margin = Sales price per unit $14 $35 = 40% Contribution margin ratio Contribution margin = $ 7, 700 Sales revenue $19, 250 = 40% Numbers above are from the Kay’s e-tail poster example on previous slides. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 10
S 7 -1 Bay Cruiseline offers nightly dinner cruises off the coast of Miami, San Francisco, and Seattle. Dinner cruise tickets sell for $50 per passenger. Bay Cruiseline’s variable cost of providing the dinner is $20 per passenger, and the fixed cost of operating the vessels (depreciation, salaries, docking fees, and other expenses) is $210, 000 per month. The company’s relevant range extends to 15, 000 monthly passengers. a. What is the contribution margin per passenger? Sales revenue (1 passenger). . . . . Less: Variable expenses. . . Contribution margin. . . Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 11
S 7 -1 (continued) b. What is the contribution margin ratio? Contribution Unit contribution margin = margin ratio = Sales price per unit = $ 30 = ? $ 50 c. Use the unit contribution margin to project operating income if monthly sales total 10, 000 passengers. ? d. Use the contribution margin ratio to project operating income if monthly sales revenue totals $400, 000. Contribution margin ( $400, 000 sales X 60%) Fixed cost Operating Income Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 12
S 7 -2 Bay Cruiseline offers nightly dinner cruises off the coast of Miami, San Francisco, and Seattle. Dinner cruise tickets sell for $50 per passenger. Bay Cruiseline’s variable cost of providing the dinner is $20 per passenger, and the fixed cost of operating the vessels (depreciation, salaries, docking fees, and other expenses) is $210, 000 per month. The company’s relevant range extends to 15, 000 monthly passengers. • If Bay Cruiseline sells an additional 500 tickets, by what amount will its operating income increase (or operating loss decrease)? Contribution Margin per unit x additional tickets Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 13
Learning Objective 2 Use CVP analysis to find breakeven points and target profit volumes Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 14
Breakeven Point Breakeven point: • Sales level at which operating income is zero • Fixed expenses = total contribution margin • Total sales = total expenses Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 15
Calculating Breakeven Point Three approaches to calculating breakeven: 1. Income statement approach 2. Shortcut approach using unit contribution margin 3. Shortcut approach using contribution margin ratio Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 16
Income Statement Approach Contribution Margin Income Statement Sales - Variable Expenses Contribution Margin - Fixed Expenses Operating Income Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 17
Short-Cut Approach to Calculating Breakeven Using the Unit Contribution Margin Units sold = Fixed expenses + Operating income Contribution margin per unit Units sold = $7, 000 + $0 $14 = 500 posters Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 18
Short-Cut Using the Unit Contribution Margin Ratio Sales in $ = Fixed expenses + Operating income Contribution margin ratio Sales in $ = = $7, 000 + $0 0. 40 $17, 500 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 19
Finding the Volume Needed for a Target Profit Using Unit CM CVP analysis helps managers determine what they need to sell to earn a target amount of profit. Units sold = Fixed expenses + Operating income Contribution margin per unit Units sold = $7, 000 + $4, 900 = $14 $11, 900 $14 = 850 posters x $35 = $29, 750 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 20
Finding the Volume Needed for a Target Profit Using Ratio CVP analysis helps managers determine what they need to sell to earn a target amount of profit. Units sold = Fixed exp + Target operating income Contribution margin ratio Units sold = $7, 000 + $4, 900 = 0. 40 $11, 900 0. 40 = 29, 750 posters Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 21
S 7 -3 Use the information from the Bay Cruiseline Data Set to compute the number of dinner cruise tickets it must sell to break even. a. Use the income statement equation approach. ($50 x units) – ($20 x units) ($50 – $20 ) x units - $210, 000 = $0 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 22
S 7 -3 (continued) Use the information from the Bay Cruiseline Data Set to compute the number of dinner cruise tickets it must sell to break even. b. Using the shortcut unit contribution margin approach, perform a numerical proof to ensure that your answer is correct. Units sold = Fixed expenses + Operating income Contribution margin per unit Units sold = ? Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 23
S 7 -3 (continued) Use the information from the Bay Cruiseline Data Set to compute the number of dinner cruise tickets it must sell to break even. c. Use your answers from a and b to determine the sales revenue needed to break even. 7, 000 units to break even X $50 sales price = ? Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 24
S 7 -3 (continued) Use the information from the Bay Cruiseline Data Set to compute the number of dinner cruise tickets it must sell to break even. d. Use the shortcut contribution margin ratio approach to verify the sales revenue needed to break even. Sales in $ = Fixed expenses + Operating income Contribution margin ratio Sales in $ = ? Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 25
Graphing the CVP Relationships Step 1: – Choose a sales volume (Units x $Price) – Plot point for total sales revenue – Draw sales revenue line from origin through the plotted point Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 26
Preparing a CVP Chart Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 27
Preparing a CVP Chart Step 2: Draw the fixed cost line $4, 000 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 28
Preparing a CVP Chart Step 3: Draw the total cost line (fixed plus variable) Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 29
Preparing a CVP Chart Step 4: Identify the breakeven point and the areas of operating income and loss Breakeven point Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 30
Preparing a CVP Chart Step 5: Mark operating income and operating loss areas on graph Breakeven point Ope ng i t a r e I m nco s Los g atin r Ope Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 31
S 7 -5 s e u en v Re Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 32
S 7 -5 (continued) Fixed Cost Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 33
S 7 -5 (continued) Breakeven Point Total Cost A Loss rea e. A m o c In rea Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 34
Learning Objective 3 Perform sensitivity analysis in response to changing business conditions Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 35
Sensitivity Analysis Managers need to be prepared for increasing costs, pricing pressure from competitors, and other changing business conditions. Sensitivity Analysis: • Conducts “What if” analysis Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 36
What if the Sales Price Changes? • Calculate a new unit contribution margin using the new sales price • Use the new unit contribution margin to compute breakeven sales in units • Use the new unit contribution margin to compute breakeven sales to maintain target profit • Using the new breakeven numbers, decide if a change should be made Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 37
What if Costs Change? • Calculate a new unit contribution margin using the new cost • Use the new unit contribution margin to compute breakeven sales in units • Use the new unit contribution margin to compute breakeven sales to maintain target profit • Using the new breakeven numbers, decide if a change should be made Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 38
What if Fixed Costs Change? • Changes in fixed costs do not affect the contribution margin • Breakeven point changes because fixed costs change • Use the unit contribution margin to compute the new breakeven sales in units • Use the unit contribution margin to compute breakeven sales to maintain target profit • Using the new breakeven numbers, decide if a change should be made Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 39
Learning Objective 4 Find breakeven and target profit volumes for multiproduct companies Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 40
Breakeven in Sales Revenue: Multiproduct Firm Total expected contribution margin: Regular posters (500 x $14). . . . $ 7, 000 Large posters (300 x $30). . . . $ 9, 000 Total expected contribution margin. . . . $16, 000 Divided by total expected sales revenue: Regular posters (500 x $35). . . . $17, 500 Large posters (300 x $70). . . . . 21, 000 Total expected sales. . . . . ÷ $38, 500 Contribution margin ratio. . . . = 41. 558% Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 41
Breakeven in Sales Revenue: Multiproduct Firm (continued) Units sold = Fixed expenses + Operating income Contribution margin ratio Units sold = $7, 000 + 0 0. 41558 = $7, 000 0. 41558 = $16, 844 (rounded) Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 42
Information Technology and Sensitivity Analysis • Allows managers to perform a wide array of sensitivity analyses before committing to decisions. • Uses Excel spreadsheets to perform sensitivity analyses • Allows managers to estimate how one change (or several simultaneous changes) affects business operations • Uses spreadsheet software to create CVP graphs Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 43
S 7 -9 Regular Cruise Executive Cruise Sales price per ticket $50 $130 Variable expense per passenger $20 $40 Assuming that Bay Cruiseline expects to sell four regular cruises for every executive cruise, compute the weighted-average contribution margin per unit. Sales Mix Calculation Regular Sales price per unit. . . $ 50 Less: Variable cost per unit. . . (20) Contribution margin per unit. . . . Sales mix. . . . . Contribution margin. . . . . Weighted-average contribution margin per unit ($210/5). . . Executive $130 (40) Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Total 44
S 7 -9 (continued) Sales Mix Calculation Regular Sales price per unit. . . $ 50 Less: Variable cost per unit. . . (20) Contribution margin per unit. . . . Sales mix. . . . . Contribution margin. . . . . Weighted-average contribution margin per unit ($210/5). . . Executive $130 (40) Total Is it higher or lower than a simple average contribution margin? Why? Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 45
S 7 -9 (continued) Sales Mix Calculation Regular Sales price per unit. . . $ 50 Less: Variable cost per unit. . . (20) Contribution margin per unit. . . . Sales mix. . . . . Contribution margin. . . . . Weighted-average contribution margin per unit ($210/5). . . Executive $130 (40) Total Will this new sales mix cause Bay Cruiseline’s breakeven point to increase or decrease from what it was when it sold only regular cruises? Sales in $ = Fixed expenses + Operating income Weighted Average Contribution margin per unit ? = Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 46
What if the Sales Mix Changes? • Use the same CVP formula for multiple products. • Use the weighted-average contribution margin per unit of all products. • Can find the breakeven or the target profit volume in terms of units, or in terms of sales revenue. Sales Mix Calculation Regular Product Sales price per unit. . . $ 35 Less: Variable cost per unit. . . (21) Contribution margin per unit. . . . Sales mix. . . . . Contribution margin. . . . . Weighted-average contribution margin per unit ($160/8). . . Large Product $ 70 (40) Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Total 47
Learning Objective 5 Determine a firm’s margin of safety and operating leverage Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 48
Common Indicators of Risk • Margin of Safety – The excess of expected sales over breakeven sales • Operating Leverage • The relative amount of fixed and variable costs that make up a company’s total costs Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 49
Margin of Safety • Excess of expected sales over breakeven sales • Drop in sales that the company can absorb before incurring a loss • Used to evaluate the risk of current operations as well as the risk of new plans Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 50
Margin of Safety Margin of safety Expected sales Breakeven = − sales in units 450 units = 950 units − 500 units Margin of safety = Expected sales Breakeven − in dollars sales = $33, 250 = $15, 750 – $17, 500 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 51
Margin of Safety as a Percentage Margin of safety = as a percentage Margin of safety in units Expected sales in units = 450 Units 950 Units = 47. 4% (rounded) Margin of safety = as a percentage = = Margin of safety in dollars Expected sales in dollars $15, 750 $33, 250 47. 4% (rounded) Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 52
Operating Leverage Factor • How responsive a company’s operating income is to changes in volume – Lowest possible value for this factor is 1, if the company has no fixed costs Operating leverage factor = Contribution margin Operating income Operating leverage factor = $13, 300 $6, 300 = 2. 11 (rounded) Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 53
High Operating Leverage • High operating leverage companies have: – Higher levels of fixed costs and lower levels of variable costs – Higher contribution margin ratios • For high operating leverage companies, changes in volume significantly affect operating income, so they face: – Higher risk – Higher potential for reward • Examples include golf courses, hotels, rental car agencies, theme parks, airlines, cruise lines Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 54
Low Operating Leverage • Low operating leverage companies have: – Higher levels of variable costs and lower levels of fixed costs – Lower contribution margin ratios • For low operating leverage companies, changes in volume do NOT have as significant an effect on operating income, so they face: – Lower risk – Lower potential for reward • Examples include merchandising companies. Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 55
End of Chapter 7 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 56
- Slides: 56