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CVP Analysis and Break Even Point

CVP Analysis and Break Even Point

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Published by MUNAWAR ALI

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Categories:Types, Business/Law
Published by: MUNAWAR ALI on Sep 18, 2009
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CVP Analysis and Break Even Point
Posted: August 24, 2009 at 11:38 am | Tags:Break Even Point,CVP Analysis  I will utilize this fictional company as an example in each of the post below. My fictional company, Henry’sMiracle Stomach Elixer Co, produces and sells stomach elixir next to the Saint Henry River in Escuintla,Guatemala, a very popular tourist attraction. The bottles are sold to tourists at a stand adjacent to said riverat a price of $7 (American dollars). This water is rumored to cure travelers diarrhea, but only if it is blessedby the local priest, Enrique, who has signed an exclusive contract with this company. Henry, the company’sowner, produces a weekly balance sheet and income statement at the end of each week. We will utilize thefirst week of June of 2009 which starts on a Monday.On the last Friday in May Henry, the company’s owner, produces a balance sheet and income statement fromthe week before. From this exercise Henry records some facts and numbers that will be useful for the nextweek;
Variable Costs
o
Decorative Bottles used to store 8 fl ounces of Henry’s Miracle Stomach Elixir at a cost of $1 each
o
Decorative String used to decorate the bottles at a cost of .05 each.
o
Decorative sticky labels that are put on the bottle at a cost of .05 each
o
Fine print legal disclaimer stickers bought from Henry’s brother, Heinz, the town lawyer at a cost of .75 each.
o
Bottles of American bottled water at a cost of .50 each purchased from the town import exportexpert, Harry.
o
Tablets of Loperamide (Imodium) to be dissolved in water at .25 each. Purchased from the towndoctor, Enrico.
o
Fixed Costs
$10 a week. Rent for souvenir stand spot in between the public water fountain and the very popularTaco Grande stand.
Raw Materials Beginning Inventory and Cost
1000 decorative bottles
1000 decorative strings
1000 decorative sticky labels
1000 fine print legal disclaimer stickers
1000 bottles of American bottled water
There is never work in process inventory.
Henry buys new raw materials on the 15
th
of each month
Direct Labor Costs
Henrietta, Henry’s wife, assembles the bottles at .25 cents per bottle.
Enrique, Henry’s son and also the town priest gets paid .25 cents per blessing of one bottle.
Indirect Labor Costs
Harriet , Henry’s daughter gets paid 10.00 a week salary to clean up the assembly work space
Finished Goods Inventory
100 bottles at a cost of $2.60 (direct materials and direct labor) each.
The company’s salesman Heinrick gets paid a commission of .25 a bottle and no salary.
 
It was midnight on Friday and Henry could not sleep. After reviewing his favorite blogs he stumbled upon asite that covered variable vs. fixed costs, cost-volume profit (CVP) relationships and break even analysis.These concepts interested Henry because he was never sure what his profit would be until the end of theweek. Being the curious businessman he is, Henry decided to see how all of this relates to his MiracleStomach Elixir business. Henry was familiar with the concept of variable vs. fixed costs. His weeklysummary always broke down costs by variable vs. fixed. Variable costs are costs that vary, in total, inproportion to the changes in levels of activity. All of Henry’s direct materials and direct labor costs werevariable costs. Fixed costs are costs that remain constant in total within the relevant range. Henry’s weeklyrent and daughter’s salary were fixed expenses. In order to get started in applying CVP Henry had to firstcreate a Contribution Margin Income Statement. The Contribution Margin Income Statement tells managerswhat their contribution margin is. The contribution margin is the difference between total sales and totalvariable expenses. This amount is used to cover fixed expenses and what is left over is net operatingincome. Once you have the contribution margin you are able to calculate your breakeven point. Thebreakeven point is the point at which profit is equal to 0. It is the point where the contribution margincovers your fixed expenses. Below is Henry’s Contribution Margin Income statement:
Contribution Margin IncomeStatement (1 Week) TOTAL PER UNITSales (200 bottles at $7 per unit) $ 1,400.00 $ 7.00Goods Available For Sale $ 1,055.00(less)Ending Inventory $ (390.00)Variable Cost of Goods Sold $ 665.00Adjust Cost of Goods Sold (minus Harriet’sfixed salary)$ (10.00)Variable Selling and Admin Expenses(Heinricks Commission)$ 50.00$ 705.00 $ 3.53Contribution Margin $ 695.00 $ 3.48Fixed Expenses (Rent and Harriet’sSalary)$ (20.00)Net Operating Income$ 675.00
From here Henry can determine his breakeven point by using the following formula;
(Break Even Point in Units = Fixed expenses/Contribution margin)(Breakeven point in Units sold=20/3.48=5.7 units (6 Units)
Henry must sell six units a week in order to break even. In order to determine Henry’s breakeven point intotal sales dollars Henry must first calculate the company’s contribution margin ratio using the followingformula;
(CM Ratio=Contribution margin/ total sales)(CM Ratio = 695/1400=49.6%).

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