Cost Management

Chapter 3 Cost-Volume-Profit Analysis

Prepared by Gail Kaciuba Midwestern State University

© John Wiley & Sons, 2005 Chapter 3: Cost-Volume-Profit Analysis Eldenburg & Wolcott’s Cost Management, 1e Slide # 1

Chapter 3: Cost-Volume-Profit Analysis

Learning objectives

• • • • • • Q1: What is cost-volume-profit (CVP) analysis, and how is it used for decision making? Q2: How are CVP calculations performed for a single product? Q3: How are CVP calculations performed for multiple products? Q4: What is the breakeven point? Q5: What assumptions and limitations should managers consider when using CVP analysis? Q6: How are the margin of safety and operating leverage used to assess operational risk? Chapter 3: Cost-Volume-Profit Analysis Eldenburg & Wolcott’s Cost Management, 1e Slide # 2

© John Wiley & Sons, 2005

Q1, Q4: CVP Analysis and the Breakeven Point • CVP analysis looks at the relationship between selling prices, sales volumes, costs, and profits. • The breakeven point (BEP) is where total revenue equal total costs. $ BEP in sales $ Total Revenue (TR)

Total Costs (TC)

units BEP in units

© John Wiley & Sons, 2005 Chapter 3: Cost-Volume-Profit Analysis Eldenburg & Wolcott’s Cost Management, 1e Slide # 3

Q1: How is CVP Analysis Used? • CVP analysis can determine, both in units and in sales dollars: • the volume required to break even • the volume required to achieve target profit levels • the effects of discretionary expenditures • the selling price or costs required to achieve target volume levels • CVP analysis helps analyze the sensitivity of profits to changes in selling prices, costs, volume and sales mix. © John Wiley & Sons, 2005 Chapter 3: Cost-Volume-Profit Analysis Eldenburg & Wolcott’s Cost Management, 1e Slide # 4

Q2: CVP Calculations for a Single Product

Units required to F + Profit achieve target = Q = P -V pretax profit where F = total fixed costs P = selling price per unit V = variable cost per unit P - V = contribution margin per unit

To find the breakeven point in units, set Profit = 0.

Chapter 3: Cost-Volume-Profit Analysis Eldenburg & Wolcott’s Cost Management, 1e

© John Wiley & Sons, 2005

Slide # 5

Q2: CVP Calculations for a Single Product

Sales $ required to achieve target = F + Profit CMR pretax profit where F = total fixed costs CMR = contribution margin ratio = (P- V)/P Note that CMR can also be computed as

Total Revenue − Total Variable Costs CMR = Total Revenue

To find the breakeven point in sales $, set Profit = 0.

© John Wiley & Sons, 2005 Chapter 3: Cost-Volume-Profit Analysis Eldenburg & Wolcott’s Cost Management, 1e Slide # 6

Q2: Breakeven Point Calculations

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.

F +0 $360,000 BEP in units = = P − V $200 / unit − $80 / unit $360,000 = = 3,000 units $120 / unit F $360,000 F +0 = = BEP in sales $ = (P − V ) / P ($200 − $80) / $200 CMR $360,000 = = $600,000 60% © John Wiley & Sons, 2005 Chapter 3: Cost-Volume-Profit Analysis Eldenburg & Wolcott’s Cost Management, 1e Slide # 7

Q2: CVP Graph

Draw a CVP graph for Bill’s Briefcases. What is the pretax profit if Bill sells 4100 briefcases? If he sells 2200 briefcases? Recall that P = $200, V = $80, and F = $360,000. TR $1000s $600 $360 -$96,000 $132,000

Profit at 4100 units = $120 x 4100 - $360,000.

TC

Profit at 2200 units = $120 x 2200 - $360,000. More easily: 4100 units is 1100 units past BEP, so profit = $120 x 1100 units; 2200 units is 800 units before BEP, so loss = $120 x 800 units. 3000 4100

2200

© John Wiley & Sons, 2005

units

Chapter 3: Cost-Volume-Profit Analysis Eldenburg & Wolcott’s Cost Management, 1e

Slide # 8

Q2: CVP Calculations

How many briefcases does Bill...