Accounting Summary Session 1

Profit
Profit measures the economic value generated by an activity
Profit = revenue – costs
For-profit organizations: generate wealth for society if they generate a profit. Those
for-profit organizations that generate losses consistently disappear.
Non-profit organizations: serve people who cannot pay for the products and
services or pursue a mission where profit has little or no relevance. These
organizations are funded through donations and public sources.
The ethical way of doing business is more important than profits. Being ethical means
that people and the environment are the main priority.

Opportunity Cost
Opportunity costs: the economic value of the best forgone alternative
The alternative that generates the most cash flow is the preferred alternative (from
an economic perspective)

Cost Behavior
Fixed costs: costs that happen no matter how many units are sold
Variable costs: grow as the level of activity grows
Mixed costs (semi-variable): costs that contain a portion of both fixed and variable
costs
Costs are variable or fixed over a certain range, the relevant range. Outside that
range, their behavior changes.
Step costs: fixed costs over small ranges
Discretionary costs: costs that can be changed on the short-term
Committed costs: costs that are hard to change (long-term)
Contribution Margin
Total contribution margin tells you how much money your company generates
before paying for its fixed costs
Total contribution margin = revenues – variable costs or
Contribution margin per unit = price per unit – variable costs per unit or
(Revenues − variable costs)
Contribution margin ratio (%) = or
Revnue
(price per unit − variable costs per unit)
Contribution margin ratio (%) =
Price per unit

Higher fixed costs are associated with riskier businesses because fixed costs exist
regardless of how much is sold.
This is why the relationship between fixed and variable costs is an important variable
called operating leverage
Total fixed costs
Operating leverage =
Total costs

Break-even Analysis
Break-even analysis is a management tool widely used by managers to assess the
attractiveness of various scenarios.
Break-even is the number of units that must be sold to have zero profit.
Fixed costs
Break-even point (in number of units sold) =
contribution margin per unit

Fixed costs
Break-even point (in € sold) =
contribution margin ratio (%)

Break-even point is the point where sales and costs are equal
Another way to use break-even analysis is to change the values of the equation
variables. This is called sensitivity analysis or what-if analysis. It looks at the
change of the break-even point if the variables are changed.