Cost-Volume-Profit Analysis

- Is a powerful tool for planning and decision making because it emphasizes the
interrelationships of cost, quantity sold, and price which brings together all of the
financial information of the firm.
- It can be a valuable tool in identifying the extent and magnitude of the economic
trouble a company is facing and helping pinpoint the necessary solution.

The Break-even Point & Target Profit in Units and Sales Revenue
- To find out how revenues, expenses, and profits behave as volume changes, it is
natural to begin by finding the firm’s break-even point in units sold and in sales
revenue.

Frequently used approaches to finding break-even point

1. Operating income approach

2. Contribution margin approach

Steps in implementing a unit-sold approach to CVP

1. Determine what a unit is.

2. Separate costs into fixed and variable components
Reminder: CVP focuses on the firm as a whole. Therefore, all costs of the company are
taken into account.

Variable cost Fixed costs

1. Direct materials 1. Fixed costs

2. Direct labor 2. Fixed overhead
3. Variable overhead 3. Fixed selling
4. Variable Selling 4. Administrative expenses
5. Fixed Selling

Basic concepts for CVP Analysis

- Firms costs can be broken down into variable and fixed costs. A useful tool for
organizing the firm’s costs into fixed and variable categories is the
contribution-margin-based income statement.
 Formulas:

1. Variable Product cost per unit

= Direct Materials + Direct Labor + Variable overhead

2. Selling expenses per unit

= Administrative expenses x percentage of variable selling expense

3. Variable cost per unit

= Direct Materials + Direct Labor + Variable overhead + Selling expenses per unit

4. Contribution margin unit

= Price - Variable cost per unit

5. Contribution margin per ratio

= (Price - Variable cost per unit)/Price

6. Total Fixed expense

= fixed factory overhead + administrative selling expense

Administrative selling expenses= Units plan to sell x administrative selling expense

Blazin-Boards Company
Contribution-Margin-Based Operating Income Statement
For the Coming Year
Sales
Less: Total variable expenses (variable cost per unit x units to be sold)
Total contribution margin
Less: Total fixed expense x
Operating income

If there is an increase in sale:

Increase in sales (3.000 boards x $400)
Less:
Increase in variable cost (3.000 boards x $240)
Increase in Fixed cost 0
Increase in operating income

The Equation Method for Break-Even and Target Income

Basic Break Even target income equation
Operating income= Sales- Variable Expenses- Fixed Expenses
Expanded Equation
Operating income= (Price x num of units) - (Variable cost per unit x Num of units) - Total
fixed cost
Units for a target profit= (Total fixed cost + Target income)/ (Price - Variable cost per unit)
Break-even units = (Total fixed cost + 0)/ (Price - Variable cost per unit)
= Total fixed cost/(Price - Variable cost per unit)
 Contribution Margin Approach
- The contribution margin is Sales revenue - total variable cost, by substituting the
unit contribution margin for price minus unit variable cost in the operating income
equations.
Number of units= Fixed cost/Unit contribution margin

Break-Even Point and Target Income in Sales Revenue

Sales-revenue approach by looking at the basic income statement.

Formula

1. Break-even sales revenue

= Total fixed cost/Contribution margin ratio

2. Target sales revenue

= (Total fixed cost + Target profit)/ Contribution margin ration

After-Tax Profit Targets

Formula:

1. After-tax profit (net income)

= Operating income - Income Taxes
Or = Operating income - (tax rate x operating income)
Or = Operating income (1 - Tax rate)

2. Before-tax income
=After tax income/(1-Tax rate)

3. Number of boards
= (Total fixed cost + target profit)/(Price - Variable cost per unit)

Direct fixed expenses

- Fixed costs that can be traced to each segment & would be avoided if the segment
did not exist.
Common fixed expenses
- Fixed costs that are not traceable to the segments and that would remain even if one
of the segments was eliminated.
Sale Mix
- The relative combination of products being sold by a firm.
Profit-volume graph
- Portrays the relationship between profits and sales volume.
Formula:
Operating income= (Price x Units)- (Unit variable cost x Units) - Fixed cost
Cost- Volume-Profit Graph
- Depicts the relationships among cost, volume and profits.

Formula

1. Revenue lines
= Price x units

2. Total cost lines

= (Unit variable cost x Units) + Fixed costs

Assume of cost-volume-profit analysis

1. Assumes a linear revenue function and a linear cost function

2. Price, total fixed costs, and unit variable costs can be accurately identified and
remain constant over the relevant page.
3. What is produced is sold
4. Sales mix is assumed to be known
5. Selling prices and costs are assumed to be known with certainty.

Margin of safety
- The units sold or expected to be sold or the revenue earned or expected to be
earned above the break-even volume
CVP ANALYSIS AND NON-UNIT COST DRIVERS
- Assumes that all cost of the firm can be divided into two categories: those that vary
with sales volume (variable costs) and those that do not (fixed costs)