16 -1

Cost-Volume-Profit
Analysis: A Managerial
Planning Tool
 16 -2

Objectives
Objectives
1. Determine the number
After of units
studying this that must be
After studying this
sold to breakchapter,
even oryou
earnshould
a target profit.
chapter, you should
2. Calculate the amount
be of
able revenue
to:
be able to: required to
break even or to earn a targeted profit.
3. Apply cost-volume-profit analysis in a
multiple-product setting.
4. Prepare a profit-volume graph and a cost-
volume-profit graph, and explain the meaning
of each.
 16 -3

Objectives
Objectives
5. Explain the impact of risk, uncertainty, and
changing variables on cost-volume-profit
analysis.
6. Discuss the impact of activity-based costing
on cost-volume-profit analysis
 16 -4

Using
Using Operating
Operating Income
Income in
in CVP
CVP Analysis
Analysis

Narrative Equation

Sales revenue
– Variable expenses
– Fixed expenses
= Operating income
 16 -5

Using
Using Operating
Operating Income
Income in
in CVP
CVP Analysis
Analysis

Sales (1,000 units @ $400)

$400,000
Less: Variable expenses

325,000
Contribution margin

$ 75,000
Less: Fixed expenses
 16 -6

Using
Using Operating
Operating Income
Income in
in CVP
CVP Analysis
Analysis
Break Even in Units

0 = ($400 x Units) – ($325 x Units) – $45,000

$400,000 ÷ $325,000 ÷
1,000 1,000
 16 -7

Using
Using Operating
Operating Income
Income in
in CVP
CVP Analysis
Analysis
Break Even in Units
0 = ($400 x Units) – ($325 x Units) – $45,000
0 = ($75 x Units) – $45,000
$75 x Units = $45,000
Units = 600 Proof
Proof
Sales
Sales(600
(600units)
units) $240,000
$240,000
Less:
Less: Variable
Variableexp.
exp. 195,000
195,000
Contribution
Contributionmargin
margin $$ 45,000
45,000
Less:
Less: Fixed
Fixedexpenses
expenses 45,000
45,000
Operating
Operatingincome
income $$ 00
 16 -8

Achieving
Achieving aa Targeted
Targeted Profit
Profit
Desired Operating Income of $60,000
$60,000 = ($400 x Units) – ($325 x Units) – $45,000
$105,000 = $75 x Units
Units = 1,400
Proof
Proof
Sales
Sales(1,400
(1,400units)
units) $560,000
$560,000
Less:
Less: Variable
Variableexp.
exp. 455,000
455,000
Contribution
Contributionmargin
margin $105,000
$105,000
Less:
Less: Fixed
Fixedexpenses
expenses 45,000
45,000
Operating
Operatingincome
income $$ 60,000
60,000
 16 -9

Targeted Income as a Percent of Sales Revenue

Desired Operating Income of

15% of Sales Revenue
0.15($400)(Units) = ($400 x Units) – ($325 x Units) – $45,000
$60 x Units = ($400 x Units) – $325 x Units) – $45,000
$60 x Units = ($75 x Units) – $45,000
$15 x Units = $45,000
Units = 3,000
 16 -10

After-Tax
After-Tax Profit
Profit Targets
Targets

Net income = Operating income – Income taxes

= Operating income – (Tax rate x Operating income)
= Operating income (1 – Tax rate)

Or

Net income
Operating income =
(1 – Tax rate)
 16 -11

After-Tax
After-Tax Profit
Profit Targets
Targets
If the tax rate is 35 percent and a firm wants
to achieve a profit of $48,750. How much is
the necessary operating income?
$48,750 = Operating income – (0.35 x Operating income)
$48,750 = 0.65 (Operating income)
$75,000 = Operating income
 16 -12

After-Tax
After-Tax Profit
Profit Targets
Targets
How many units would have to be sold to
earn a net income of $48,750?
Units = ($45,000 + $75,000)/$75
Units = $120,000/$75 Proof
Proof
Units = 1,600 Sales
Sales(1,600
(1,600units)
units) $640,000
$640,000
Less:
Less: Variable
Variableexp.
exp. 520,000
520,000
Contribution
Contributionmargin
margin $120,000
$120,000
Less:
Less: Fixed
Fixedexpenses
expenses 45,000
45,000
Operating
Operatingincome
income $$ 75,000
75,000
Less:
Less: Income
Incometax
tax(35%)
(35%) 26,250
26,250
Net
Netincome
income $$ 48,750
48,750
 16 -13

Break-Even
Break-Even Point
Point in
in Sales
Sales Dollars
Dollars

First,
First, the
the contribution
contribution margin
margin
ratio
ratio must
must be
be calculated.
calculated.

Sales
Sales $400,000
$400,000 100.00%
100.00%
Less:
Less: Variable
Variable
expenses
expenses 325,000
325,000 81.25%
81.25%
Contribution
Contribution
margin
margin $$ 75,000
75,000 18.75%
18.75%
Less:
Less: Fixed
Fixedexp.
exp. 45,000
45,000
Operating
Operatingincome
income $$ 30,000
30,000
 16 -14

Break-Even
Break-Even Point
Point in
in Sales
Sales Dollars
Dollars
Given a contribution margin ratio of 18.75%, how
much sales revenue is required to break even?
Operating income = Sales – Variable costs – Fixed costs
$0 = Sales – (Variable costs ratio x Sales)
– $45,000
$0 = Sales (1 – 0.8125) – $45,000
Sales (0.1875) = $45,000
Sales = $240,000
 16 -15

Relationships
Relationships Among
Among Contribution
Contribution
Margin,
Margin, Fixed
Fixed Cost,
Cost, and
and Profit
Profit
Fixed Cost = Contribution Margin

Fixed Cost

Contribution Margin

Revenue
Total Variable Cost
 16 -16

Relationships
Relationships Among
Among Contribution
Contribution
Margin,
Margin, Fixed
Fixed Cost,
Cost, and
and Profit
Profit
Fixed Cost < Contribution Margin

Fixed Cost Profit

Contribution Margin

Revenue
Total Variable Cost
 16 -17

Relationships
Relationships Among
Among Contribution
Contribution
Margin,
Margin, Fixed
Fixed Cost,
Cost, and
and Profit
Profit
Fixed Cost > Contribution Margin

Fixed Cost Loss

Contribution Margin

Revenue
Total Variable Cost
 16 -18

Profit
Profit Targets
Targets and
and Sales
Sales Revenue
Revenue
How much sales revenue must a firm generate to
earn a before-tax profit of $60,000. Recall that
fixed costs total $45,000 and the contribution
margin ratio is .1875.
Sales = ($45,000 + $60,000)/0.1875
= $105,000/0.1875
= $560,000
 16 -19

Multiple-Product
Multiple-Product Analysis
Analysis
Manual Automatic
Mower Mower Total
Sales $480,000 $640,000 $1,120,000
Less: Variable expenses 390,000 480,000 870,000
Contribution margin $ 90,000 $160,000 $ 250,000
Less: Direct fixed expenses 30,000 40,000 70,000
Product margin $ 60,000 $120,000 $ 180,000
Less: Common fixed expenses 26,250
Operating income $ 153,750
 16 -20

Income
Income Statement:
Statement: B/E
B/E Solution
Solution
Manual Automatic
Mower Mower Total
Sales $184,800 $246,400 $431,200
Less: Variable expenses 150,150 184,800 334,950
Contribution margin $ 34,650 $ 61,600 $ 96,250
Less: Direct fixed expenses 30,000 40,000 70,000
Segment margin $ 4,650 $ 23,600 $ 26,250
Less: Common fixed expenses 26,250
Operating income $ 0
 16 -21

The
The profit-volume
profit-volume graph
graph portrays
portrays
the
the relationship
relationship between
between profits
profits
and
and sales
sales volume.
volume.
 16 -22

Example
The Tyson Company produces a single product
with the following cost and price data:
Total
Total fixed
fixed costs
costs $100
$100
Variable
Variable costs
costs per
per unit
unit 55
Selling
Selling price
price per
per unit
unit 10
10
 16 -23
Profit-Volume Graph
(40, $100)
I = $5X - $100
Profit $100—
or Loss 80—
60—
40— Break-Even Point
(20, $0)
20—
0— | | | | | | | | | |
5 10 15 20 25 30 35 40 45 50
- 20— Units Sold
- 40— Loss
-60—
-80—
-100— (0, -$100)
 16 -24

The
The cost-volume-profit
cost-volume-profit graph
graph
depicts
depicts the
the relationship
relationship among
among
costs,
costs, volume,
volume, and
and profits.
profits.
 16 -25

Cost-Volume-Profit Graph
Revenue
Total Revenue
$500 --
450 --
451 --
1 0 0) Total Cost
452 -- f i t ($
Pro
453 --
250 -- Variable Expenses
200 -- ($5 per unit)
Break-Even Point
150 --
(20, $200)
100 --
Loss
50 -- Fixed Expenses ($100)
0 -- | | | | | | | | | | | |
5 10 15 20 25 30 35 40 45 50 55 60
Units Sold
 16 -26

Assumptions
Assumptions of
of C-V-P
C-V-P Analysis
Analysis
1. The analysis assumes a linear revenue function and a
linear cost function.
2. The analysis assumes that price, total fixed costs, and
unit variable costs can be accurately identified and
remain constant over the relevant range.
3. The analysis assumes that what is produced is sold.
4. For multiple-product analysis, the sales mix is assumed
to be known.
5. The selling price and costs are assumed to be known
with certainty.
 Relevant Range
16 -27

Total Revenue

Total Cost

Units
Relevant Range
Alternative 1: If advertising expenditures increase by 16 -28
$8,000, sales will increase from 1,600 units to 1,725 units.
BEFORE THE WITH THE
INCREASED INCREASED
ADVERTISING ADVERTISING
Units sold 1,600 1,725
Unit contribution margin x $75 x $75
Total contribution margin $120,000 $129,375
Less: Fixed expenses 45,000 53,000
Profit $ 75,000 $ 76,375
DIFFERENCE IN PROFIT
Change in sales volume 125
Unit contribution margin x $75
Change in contribution margin $9,375
Less: Change in fixed expenses 8,000
Increase in profits $1,375
Alternative 2: A price decrease from $400 to $375 per 16 -29
lawn mower will increase sales from 1,600 units to 1,900
units.
BEFORE THE WITH THE
PROPOSED
PROPOSED
Units sold CHANGES
1,600CHANGES 1,900
Unit contribution margin x $75 x $50
Total contribution margin $120,000 $95,000
Less: Fixed expenses 45,000 45,000
Profit $ 75,000 $50,000

DIFFERENCE IN PROFIT

Change in contribution margin $ -25,000

Less: Change in fixed expenses --------
Decrease in profits $ -25,000
Alternative 3: Decreasing price to $375and increasing 16 -30
advertising expenditures by $8,000 will increase sales from
1,600 units to 2,600 units.
BEFORE THE WITH THE
PROPOSED
PROPOSED
Units sold CHANGES
1,600 2,600
CHANGES
Unit contribution margin x $75 x $50
Total contribution margin $120,000 $130,000
Less: Fixed expenses 45,000 53,000
Profit $ 75,000 $ 77,000

DIFFERENCE IN PROFIT

Change in contribution margin $10,000

Less: Change in fixed expenses 8,000
Increase in profit $ 2,000
 16 -31

Margin
Margin of
of Safety
Safety
Assume that a company has the following projected
income statement:
Sales $100,000
Less: Variable expenses 60,000
Contribution margin $ 40,000
Less: Fixed expenses 30,000
Income before taxes $ 10,000
Break-even point in dollars (R):
R = $30,000 ÷ .4 = $75,000
Safety margin = $100,000 - $75,000 = $25,000
 16 -32

Degree of Operating Leverage (DOL)

Degree of operating leverage= Contribution margin/Profit

DOL = $40,000/$10,000 = 4.0

Now suppose that sales are 25% higher than projected. What is
the percentage change in profits?

Percentage change in profits = DOL x percentage change in

sales
Percentage change in profits = 4.0 x 25% = 100%
 16 -33

Degree of Operating Leverage (DOL)

Proof:

Sales $125,000
Less: Variable expenses 75,000
Contribution margin $ 50,000
Less: Fixed expenses 30,000
Income before taxes $ 20,000
 16 -34

CVP
CVP and
and ABC
ABC
Assume the following:
Sales
Salesprice
priceper
perunit
unit
$15
$15
Variable
Variablecost
cost
55
Fixed
Fixedcosts
costs(conventional)
(conventional)
$180,000
$180,000
Fixed
Fixedcosts
costs(ABC)
(ABC) $100,000
$100,000with
with$80,000
$80,000subject
subjectto
toABC
ABC
analysis
analysis
Other
OtherData:
Data:
Unit
Unit
Level
Levelofof
Variable
Variable
Activity
Activity
 16 -35

CVP
CVP and
and ABC
ABC
1. What is the BEP under conventional
analysis?

BEP = $180,000 ÷ $10

= 18,000 units
 16 -36

CVP
CVP and
and ABC
ABC
2. What is the BEP under ABC analysis?

BEP = [$100,000 + (100 x $500) + (600 x

$50)]/$10
= 18,000 units
 16 -37

CVP
CVP and
and ABC
ABC
3. What is the BEP if setup cost could be reduced to
$450 and inspection cost reduced to $40?
BEP = [$100,000 + (100 x $450) + (600 x $40)]/$10
= 16,900 units
 Homework
Homework
16 -38

Please Do!
Exercise
11-7 Break-Even Revenue, Target Revenue, Break-
Even Units, Target Units (LO1, LO2)
11-11 CVP and Profit- Volume Graphs LO4
Problem
11-21 Basic CVP Concepts (LO1, LO2, LO5)
11-22 Multiple-Product Analysis; Changes in Sales Mix LO3
Bonus
11-5 Units Sold to Break Even and to Find Targeted Income (LO1)
11-6 After-Tax Target Income (LO1)
11-10 & 11.12 Margin of Safety & Operating Leverage LO2, LO3,
LO5
 16 -39

Chapter Sixteen

The
The End
End