CostVolumeProfit Analysis

1
Chapter 12
Cost-Volume-Profit Analysis
2
Chapter 12 Objectives

• Define break-even point (BEP) and
  cost-volume-profit (CVP) analysis and recognize
  their limiting underlying assumptions.
• Use CVP analysis in both single- and
  multi-product companies.
• Develop a break-even chart and profit-volume
  graph.
• Use the margin of safety and operating leverage
  concepts.

3
CVP Assumptions

• Operating within Relevant Range
• All costs are Fixed or Variable
• All Revenue and Variable costs are constant per
  unit
• Constant contribution margin (Unit Sales price-
  Unit Variable cost)
• Total fixed cost is constant.

Total Revenue
Total Cost
Sales price units Fixed Cost variable cost
units
Solving for units Break even units
Fixed cost
Sales Variable cost/unit
or
4
How many units do we need to sell to break even?
Total Revenues - Total Costs Profit R(X) -
VC(X) FC P R(X) - VC(X) - FC P   where
R revenue (selling price) per unit 50
X number of units sold (volume) R(X)
total revenues VC variable cost per unit
15 VC(X) total variable costs
FC total fixed costs 647,500 P
pre-tax profit 0
Using CVP formula
18,500 units 647,500/35
Setting profit equal to 0
or
(1) 50X - (9X 6X) - 647,500 0 (2) 50X
- 15X - 647,500 0 (3) 35X 647,500 (4) X
647,50035 (5) X 18,500 units
5
Desired Profit
To calculate sales necessary to earn a profit,
treat the profit as an additional fixed cost.
X units 647,500 150,000 35 X 22,786
units
6
After Tax Profit
To calculate the pretax earnings necessary to
generate after tax earnings
Pre tax earnings After tax earnings 1 Tax
rate
250,000150,000 1-.40
7
Multi Product Analysis

• Assume constant product mix
• Calculate contribution margin per basket
• Calculate break-even baskets
• Determine total units per product

8
Additional Concepts

• Margin of Safety
• Operating Leverage

9
Conclusions

• At break even, total cost total revenue
• There are strict assumptions in CVP analysis
• CM ratio is CM per unit/SP per unit.
• Desired profit must be adjusted for taxes.
• Multi-product CVP analysis can be accomplished.
• Operating leverage can be used in sensitivity
  analysis