Chapter 7

Cost-Volume-Profit
Analysis

McGraw-Hill/Irwin Copyright © 2014 The McGraw-Hill Companies, Inc. All rights reserved.
 The Break-Even Point
The break-even point is the point in the volume of
activity where the organization’s revenues
and expenses are equal.

7-2
 Equation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit

Unit Sales Unit Sales

sales × volume variable × volume
price in units expense in units

($500 × X) – ($300 × X) – $80,000 = $0

($200X) – $80,000 = $0
X = 400 surf boards
7-3
 Contribution-Margin Approach
Consider the following information
developed by the accountant at Curl, Inc.:
For each additional surf board sold,
Curl generates $200 in contribution
margin.

7-4
 Contribution-Margin Approach
Fixed expenses Break-even point
=
Unit contribution margin (in units)

$80,000
= 400 surf boards
$200
7-5
 Contribution-Margin Approach

Here is the proof!

400 × $500 = $200,000 400 × $300 = $120,000

7-6
 Contribution Margin Ratio

Calculate the break-even point in sales

dollars rather than units by using the
contribution margin ratio.
Contribution margin
= CM Ratio
Sales

Fixed expense Break-even point

=
CM Ratio (in sales dollars)

7-7
Contribution Margin Ratio

$80,000
= $200,000 in sales
40%
7-8
Graphing Cost-Volume-Profit Relationships

Viewing CVP relationships in a graph gives managers

a perspective that can be obtained in no other way.
Consider the following information for Curl, Inc.:

7-9
Cost-Volume-Profit Graph

Fixed expenses

7-10
Cost-Volume-Profit Graph

nses
x p e
l e
Tota
Fixed expenses

7-11
Cost-Volume-Profit Graph

nses
x p e
l e
Tota
Fixed expenses

7-12
Cost-Volume-Profit Graph

al es
t als
To

nses
x p e
l e
Tota
Fixed expenses

7-13
Cost-Volume-Profit Graph

al es
t als r e a
Break-even To o f it a
point Pr

nses
x p e
l e
Tota
Fixed expenses
area
s
Los

7-14
 Profit-Volume Graph
Some managers like the profit-volume
graph because it focuses on profits and volume.

Break-even
point r e a
t a
r o fi
P

r e a
ssa
Lo

7-15
 Target Net Profit

We can determine the number of surfboards that Curl

must sell to earn a profit of $100,000 using the
contribution margin approach.

Fixed expenses + Target profit Units sold to earn

=
Unit contribution margin the target profit

$80,000 + $100,000
= 900 surf boards
$200

7-16
 Equation Approach

Sales revenue – Variable expenses – Fixed expenses =

Profit

($500 × X) – ($300 × X) – $80,000 = $100,000

($200X) = $180,000

X = 900 surf boards

7-17
 Applying CVP Analysis

Safety Margin
⚫ The difference between budgeted sales
revenue and break-even sales revenue.
⚫ The amount by which sales can drop
before losses occur.

7-18
 Safety Margin
Curl, Inc. has a break-even point of
$200,000 in sales. If actual sales are
$250,000, the safety margin is $50,000,
or 100 surf boards.

7-19
 Changes in Fixed Costs

⚫ Curl is currently selling 500 surfboards per

year.
⚫ The owner believes that an increase of
$10,000 in the annual advertising budget,
would increase sales to 540 units.

● Should the company increase the advertising

budget?
7-20
 Changes in Fixed Costs

540 units × $500 per unit = $270,000

$80,000 + $10,000 advertising = $90,000

7-21
 Changes in Fixed Costs
Sales will increase by
$20,000, but net income
decreased by $2,000.

7-22
 Changes in Unit
Contribution Margin

Because of increases in cost of raw materials, Curl’s

variable cost per unit has increased from $300 to
$310 per surfboard. With no change in selling price
per unit, what will be the new break-even point?

($500 × X) – ($310 × X) – $80,000 = $0

X = 422 units (rounded)

7-23
 Changes in Unit
Contribution Margin

Suppose Curl, Inc. increases the price of each surfboard to

$550. With no change in variable cost per unit, what will
be the new break-even point?

($550 × X) – ($300 × X) – $80,000 = $0

X = 320 units
7-24
 Predicting Profit Given Expected Volume

Fixed expenses
Given: Unit contribution margin Find: {req’d sales volume}
Target net profit

Fixed expenses
Given: Unit contribution margin Find: {expected profit}
Expected sales volume

7-25
 Predicting Profit Given
Expected Volume
In the coming year, Curl’s owner expects to sell 525
surfboards. The unit contribution margin is
expected to be $190, and fixed costs are expected to
increase to $90,000.

Total contribution - Fixed cost = Profit

($190 × 525) – $90,000 = X

X = $99,750 – $90,000
X = $9,750 profit 7-26
Effect of Income Taxes
Income taxes affect a company’s
CVP relationships. To earn a
particular after-tax net income, a
greater before-tax income will be
required.

Target after-tax net income Before-tax

=
1 - t net income

7-27
CVP Analysis with Multiple Products
For a company with more than one product, sales
mix is the relative combination in which a
company’s products are sold.

Different products have different selling prices,

cost structures, and contribution margins.

Let’s assume Curl sells surfboards and sailboards

and see how we deal with break-even analysis.
7-28
CVP Analysis with Multiple Products
Curl provides us with the following: information:

7-29
CVP Analysis with Multiple Products
Weighted-average unit contribution margin

$200 × 62.5%

$550 × 37.5%
7-30
CVP Analysis with Multiple Products

Break-even point
Break-even Fixed expenses
=
point Weighted-average unit contribution margin

Break-even $170,000
=
point $331.25

Break-even
= 514 combined unit sales
point

7-31
CVP Analysis with Multiple Products

Break-even point
Break-even 514 combined unit sales
=
point

7-32
 Assumptions Underlying
CVP Analysis
1. Selling price is constant throughout
the entire relevant range.
2. Costs are linear over the relevant
range.
3. In multi-product companies, the sales
mix is constant.
4. In manufacturing firms, inventories
do not change (units produced = units
sold). 7-33
Cost Structure and Operating Leverage
⚫ The cost structure of an organization is the
relative proportion of its fixed and variable costs.

⚫ Operating leverage is:

⚫ the extent to which an organization uses fixed
costs in its cost structure.
⚫ greatest in companies that have a high
proportion of fixed costs in relation to variable
costs.

7-34
Measuring Operating Leverage
Operating leverage Contribution margin
=
factor Net income

$100,000
= 5
$20,000 7-35
 Measuring Operating Leverage
A measure of how a percentage change in
sales will affect profits. If Curl increases its
sales by 10%, what will be the percentage
increase in net income?

7-36
 Measuring Operating Leverage

A firm with proportionately high fixed costs has

relatively high operating leverage. On the other
hand, a firm with high operating leverage has a
relatively high break-even point.
7-37
End of Chapter 7

7-38