* Stay open in the off-season, advertise, and add a heated/covered pool * Stay open in the off-season and add a heated/covered pool (no advertising) * Stay open in the off-season, advertise and add a seasonal pool To begin our analysis, Skyview Manor’s Contribution Margin Income Statement must be analyzed for cost behaviors. A cost behavior refers to how a cost changes as an activity changes. Fixed costs remain unchanged when activity changes. Average fixed cost per unit goes down as activity goes up. This is an inverse relationship. Variable costs, however, change when activity changes. The variable cost per unit remains the same over wide ranges of activity within the relevant range. Total variable costs change directly and in proportion to changes in activity.
Break-even point for Skyview Manor is based on the number of rooms that must be rented out during the season. Break-even point is the level of sales at which profit is zero and is useful in understanding the lowest amount of activity needed to prevent losses from occurring. The analysis information is calculated on a per room basis. This information is extremely important when evaluating which alternative/option will be used to increase business and or sales.
The contribution margin (CM) approach states that each unit sold provides a certain dollar contribution, after variable expenses are paid, that goes toward covering fixed costs. Therefore, subtracting unit variable expenses from unit sale price gives the unit contribution margin. To determine how many units must be sold to break-even, divide the total fixed cost by the unit contribution margin.
Dividing total fixed costs by the contribution margin ratio, rather than the unit contribution margin, results in the break-even point in total sales dollars rather than in total units sold. Contribution margin ratio can be determined by dividing the contribution margin by sales. Knowledge of a product’s CM ratio is extremely helpful in forecasting contribution margin and net operating income.
Incremental contribution margin considers only those items of revenue, cost, and volume that will change if the new option is implemented. The incremental approach is simpler and more direct, focusing attention on specific items involved in the decision.
Cost volume profit (CVP) shows the relationship between revenue, costs, and profits along with sales volume. It assumes that unit variable costs and unit revenues are constant. CVP can be used to help find the most profitable combination of variable costs, fixed costs, selling price, and sales volume.
Skyview Manor Question 1
On average, how many rooms must be rented each night in season for the hotel to break-even?
Variable expenses were identified as cleaning supplies, linen service, and ½ of miscellaneous expenses. The remaining expenses were classified as fixed expenses. A contribution margin income statement and break-even analysis follow: Skyview Manor
Contribution Margin Income Statement
TotalPer Unit% Revenue
Cleaning Supplies 1,920 0.25 1
Linen Service 13,920 1.81 9
Misc Expenses 3,657 0.48 2
Total Variable Expenses $19,497 2.54 12
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