Chapter 5 Notes Part 2

Break-Even (BE) Analysis level of sales at which the companys profit is zero

2 methods to calculate BE in units:

- Equation Method

Profit = Unit CM X Q Fixed expense

*for Target profit just change the profit amount from 0 to the target profit amount

- Formula Method

Units sales to break even = Fixed Expenses

Unit CM

For Target profit, add the amount to the numerator

Units sales for target profit = Target Profit +Fixed Expenses

Unit CM

Break-even in Dollar sales:

Profit = CM ratio X Sales Fixed expenses

*Sales can be your unknown variable (x), then just solve for x

Or $ sales to BE = Fixed Expenses

CM Ratio

For a Target Profit, add to numerator

$ sales for a target profit = Target Profit + Fixed Expenses

CM Ratio
Margin of Safety excess of budgeted or actual sales over the break-even volume of sales dollars

Can be calculated as formula or as a percentage:

Margin of safety in dollars = Total budgeted (or actual) sales Break-even sales

Margin of safety percentage = Margin of safety in dollars

Total budgeted (or actual) sales in dollars

Operating Leverage measure of how sensitive net operating income is to a given percentage change in
dollar sales
- If operating leverage is high, a small percentage increase in sales can produce a much larger
percentage increase in net operating income

Degree of operating leverage = Contribution Margin

Net Operating Income

To see relationship of Net Operating Income with % change in sales:

% change in Net Op Income = Degree of Op Lev X % changed in sales

**If two different companies have the same total revenue and same total expense, but different cost
structures (break down between variable and fixed costs), then the company with the higher proportion
of ____________ ______________in its structure will have a higher operating leverage.

Sales Mix the proportions in which a companys products are sold

- Idea is to achieve the combination, or mix, that will bring the greatest profits
- Most companies have many products, and usually they are not equally profitable
- Profits will be greater if high-margin rather than low-margin items make up a large proportion of
total sales