The CVP graph shows the relationship between total revenues and total costs

Transcription

1 Chapter 3: Cost - Volume - Profit (CVP) Analysis Q1: What is cost-volume-profit analysis, and how is it used for decision making? CVP Analysis CVP analysis looks at the relationship between selling prices, sales volumes, costs, and profits Use CVP analysis to provide information about the following: future levels of operating activities which products/services to emphasize the amount of revenue required to avoid losses whether to increase fixed costs how much to budget for discretionary expenditures Q2: How are CVP calculations performed for a single product? CVP Calculations for a Single Product F = Total fixed costs EBT = Earnings before taxes S = Selling price per unit V = Variable cost per unit of activity (S - V) = Contribution margin per unit (CM ) F = Total fixed costs EBT = Earnings before taxes CMR = Contribution margin ratio CMR = S - V = Total revenue - Total variable costs S Total revenue Q3: What is a breakeven point? Breakeven Point The breakeven point (BEP) is where total revenue equal total costs Calculate BEP from preceding CVP formulas by setting EBIT to zero The CVP graph shows the relationship between total revenues and total costs

2 Breakeven Point Example Bill s Briefcases makes high quality cases for laptops that sell for $200. The variable costs per briefcase are $80, and the total fixed costs are $360,000. Find the BEP in units and in sales $ for this company. CVP Graph Example Draw a CVP graph for Bill s Briefcases. What is the pretax profit if Bill sells 4,100 briefcases? If he sells 2,200 briefcases? Recall that P = $200, V = $80, and F = $360,000. CVP Calculations How many briefcases does Bill need to sell to reach a target pretax profit of $240,000? What level of sales revenue is this? Recall that P = $200, V = $80, and F = $360,000. CVP with Income Taxes How many briefcases does Bill need to sell to reach a target after-tax profit of $319,200 if the tax rate is 30%? What level of sales revenue is this? Recall that P = $200, V = $80, and F = $360,000. Q4: How are CVP calculations performed for multiple products? CVP Analysis for Multiple Products When a company sells more than one product the CVP calculations must be adjusted for the sales mix. The sales mix should be stated as a proportion: Of total units sold when performing CVP calculations in units Of total revenues when performing CVP calculations in sales $

3 The weighted average contribution margin is the weighted sum of the products contribution margins: WACM CM n i=1 i i λ i = product i s % of total sales in units CM i = product i s contribution margin n = number of products The weighted average contribution margin ratio is the weighted sum of the products contribution margin ratios: n WACMR i=1 CMR i i i = product i s % of total sales revenues CMR i = product i s contribution margin ratio n = number of products

4 Q5: What assumptions and limitations should managers consider when using CVP analysis? Uncertainties & Assumptions All organizations are subject to uncertainties Consider uncertainties about: Revenue and cost estimates Interpreting results Relevant range of operations Feasibility of activity level CVP analysis assumes that costs and revenues are linear within a relevant range of activity Linear total revenues means that selling prices per unit are constant and the sales mix does not change Offering volume discounts to customers violates this assumption Linear total costs means total fixed costs are constant and variable costs per unit are constant If volume discounts are received from suppliers, then variable costs per unit are not constant If worker productivity changes as activity levels change, then variable costs per unit are not constant Uncertainties & Assumptions These assumptions may induce a small relevant range Results of CVP calculations must be checked to see if they fall within the relevant range Linear CVP analysis may be inappropriate if the linearity assumptions hold only over small ranges of activity Nonlinear analysis techniques are available (e.g., regression analysis) Q6: How are margin of safety and operating leverage used to assess operational risk? Margin of Safety The margin of safety is the excess of an organization s expected future sales (in either revenue or units) above the BEP The margin of safety can be measured in 3 ways: Degree of Operating Leverage The degree of operating leverage is the extent to which the cost function is made up of fixed costs A high degree of operating leverage indicates a high proportion of fixed costs Businesses operating at a high degree of operating leverage Face higher risk of loss when sales decrease But enjoy profits that rise more quickly when sales increase The degree of operating leverage can be computed in 3 ways:

5 The degree of operating leverage shows the sensitivity of profits to changes in sales On the prior slide Bill s degree of operating leverage was 2.5 and profits were $240,000 If expected sales were to increase to 6,000 units, a 20% increase, then profits will increase by 2.5 x 20% or 50%, to $360,000* If expected sales were to decrease to 4,500 units, a 10% decrease, then profits would decrease by 2.5 x 10%, or 25%, to $180,000** * $240,000 x 1.5 = $360,000 ** $240,000 x 0.75 = $180,000 Q7: What is the difference between contribution margin and gross margin? Contribution Margin & Gross Margin Contribution margin = sales - variable costs Gross margin = sales - cost of goods sold Service companies can calculate contribution margin but not gross margin