C V P Analysis

CVP Analysis
Understand how cost behavior and cost-volume-profit analysis are used by managers.

Cost-Profit-Volume Analysis
What is cost-volume-profit analysis?
It is the study of the effects of output volume on revenue (sales), expenses (costs), and net income (net profit).

Questions Addressed by CVP Analysis

How much must I sell to earn my desired income? How will income be affected if I reduce selling prices to increase sales volume? What will happen to profitability if I expand capacity?

Variable Costs

Fixed Costs

Mixed Costs

Cost Estimation Methods

Cost Estimation Methods are frequently required to separate the fixed and variable components of a total cost pool. Methods include:
1. 2. 3. 4. 5. Account Analysis Scattergraph High-Low Method Regression Relevant Range

Scattergraph

High-Low Method
Example: Let total costs at 500 units of output be $150,000 and at 3,000 units of output be $400,000. Calculate variable and fixed costs, respectively.

High-Low Method
Solution: High Low Change Costs: $400,000 $150,000 $250,000 Units: 3,000 500 2,500 Calculate Variable Cost Per Unit: $250,000/2,500 = $100 Calculate Total Fixed Costs: $400,000 (3,000 x 100) = $100,000

High-Low Method

Regression Analysis

Relevant Range

How Is Cost Behavior Used By Managers ?

Understanding cost behavior is vital to the managers decision-making role, because one of the main goals of management accounting is controlling costs.

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Cost-Volume-Profit Analysis
1. 2. 3. 4. 5. 6. The Profit Equation Breakeven Point Margin of Safety Contribution Margin Contribution Margin Ratio What-if Analysis

The Profit Equation

Profit = SP(x) VC(x) TFC

X = Quantity of units produced and sold SP = Selling price per unit VC = Variable cost per unit TFC = Total fixed cost

Break-Even Point
The break-even point is the level of sales at which revenue equals expenses and net income is zero.

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Break-Even Point

Break-Even Point
TFC/CM(per unit) = Break-Even (units)

X = Quantity of units produced and sold SP = Selling price per unit VC = Variable cost per unit CM = Contribution margin TFC = Total fixed cost

Contribution Margin and Gross Margin

Gross margin (which is also called gross profit) is the excess of sales over the cost of goods sold.

Contribution margin is the excess of sales over all variable costs.

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Contribution Margin
SP(u) VC(u) = CM (u)

SP = Selling price per unit VC = Variable cost per unit CM = Contribution margin u = per unit

Contribution Margin Ratio

(SP VC) / SP = CM%

SP = Selling Price per unit VC = Variable Cost per unit CM = Contribution Margin

CVP Scenario
Selling price Variable cost Difference Per Unit $5 4 $1 Percentage 100 80 20

Total monthly fixed expenses = $8,000 Rent $2,000 Labor $5,500 Other $ 500
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Equation Technique
Let N = number of units to be sold to break even $5N $4N $8,000 = 0 $1N = $8,000 N = $8,000 $1 N = 8,000 Units
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Equation Technique
Let S = sales in dollars needed to break even S 0.80S $8,000 = 0 .20S = $8,000 S = $8,000 .20 S = $40,000
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Margin of Safety
The margin of safety shows how far sales can fall below the planned level before losses occur.

Actual sales Break-even sales =

Margin of safety
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Target Net Profit

Managers can also use CVP analysis to determine the total sales, in units and dollars, needed to reach a target net profit.
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Target Net Income and Income Taxes

Revenues (2,535 $90) Variable costs (2,535 $32) Contribution margin: Fixed costs: Operating income: Income taxes: ($51,030 .30) Net income $228,150 81,120 $147,030 96,000 $ 51,030 15,309 $ 35,721
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Target Net Profit

Contribution Margin Technique Target sales volume in units = Fixed expenses + Target net income Contribution margin per unit

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