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Cost-Volume-Profit Relationships

CVP analysis is focusing on: Prices of products Volume or level of activity Per unit variable costs Total fixed costs Mix of product sold

THE BASICS OF COST-VOLUME-PROFIT (CVP) ANALYSIS


ACOUSTIC CONCEPTS, INC.
Contribution Income Statement For the Month of June
Total Sales (400 speakers) Less variable expenses.. Contribution margin. Less fixed expenses Net income.. $100,000 60,000 40,000 35,000 $ 5,000 Per Unit $250 150 $100

Contribution Margin

Operating Leverage (OL)


It is a measure of the extent to which fixed costs are being used in an organization Illustration: (the blueberry farm)
Sterling

Farm (SF) has a higher proportion of fixed costs than does Bogside Farm (BF). Total costs are the same $100,000 sales level. Previous illustration showed that with a 10% increase in sales, the net income of SF increases by 70%, whereas the net income of BF increases by only 40%. The reason is that ST has greater OL as a result of the greater amount of fixed cost in its cost structure.

OL..(cont`)

Contribution margin = Degree of operating leverage Net Income Degree of Operating Leverage is a measure, at a given level of sales, of how a percentage change in sales volume will affect profits Illustration: The degree of OL for the two farms at a $100,000 sales level would be as follows: BF: $40,000 / $10,000 = 4 SF: $70,000/ $10,000 = 7

OL..(cont`)

Automation: Risks and Rewards from a CVP Perspective

Structuring Sales Commissions

Model
XR7 Selling Price Less variable expenses Contribution margin $100 75 $ 25 Turbo $150 132 $ 18

The Concept of Sales Mix


Sales mix: the relative combination in which a company`s products are sold

Multiple Product Break Even Analysis

SOUND UNLIMITED
Contribution Income Statement For the Month of September
Le Louvre CD
Amount Percent 100 75 25

Le Vin CD
Amount $80,000 40,000 $40,000 Percent 100 50 50

Total
Amount $100,000 55,000 45,000 27,000 $18,000 Percent 100 55 45*

Sales Less variable expenses.... Contribution margin......... Less Fixed expenses.. Net Income.

$20,000 15,000 $ 5,000

Computation of the break even point: Fixed expenses. $27,000 = $60,000 Overall CM ratio, 45%

* ($45,000 : $100,000) X 100% = 45%

Multiple product Break even analysis: a shift in sales mix

SOUND UNLIMITED
Contribution Income Statement For the Month of September
Le Louvre CD
Amount Percent

Le Vin CD
Amount Percent

Total
Amount Percent

Sales
Less variable expenses.... Contribution margin......... Less Fixed expenses.. Net Income.

$80,000
60,000 $20,000

100
75 25

$20,000
10,000 $10,000

100
50 50

$100,000
70,000 30,000 27,000 $ 3,000

100
30 30*

Computation of the break even point: Fixed expenses. $27,000 = $90,000 Overall CM ratio, 30% * ($30,000 : $100,000) X 100% = 30%

Sales Mix and per Unit Contribution Margin Analysis

SOUND UNLIMITED
Per Unit Contribution Margin Analysis For the Month of September and October

Total Unit Sold


September Le Louvre CD Le Vin CD 500 2,000 2,500 October 2,000 500 2,500

Contribution Total Contribution Margin per Margin Unit September October


$10 20 $ 5,000 40,000 $45,000 $20,000 10,000 $30,000

Average per unit contribution margin September ($45,000:2,500 units) October ($30,000:2,500 units). $18 $12

Assumptions of CVP Analysis

Selling price is constant throughout the entire relevant range Costs are linear throughout the entire relevant range, and they can be accurately divided into variable and fixed elements In multi product companies, the sales mix is constant In manufacturing companies, inventories do not change

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