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Chapter 6

Chapter 6. Cost-Volume-Profit Relationships. Basics of Cost-Volume-Profit Analysis. Contribution Margin (CM) is the amount remaining from sales revenue after variable expenses have been deducted. Basics of Cost-Volume-Profit Analysis.

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Chapter 6

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  1. Chapter 6 Cost-Volume-Profit Relationships

  2. Basics of Cost-Volume-Profit Analysis Contribution Margin (CM) is the amount remaining from sales revenue after variable expenses have been deducted.

  3. Basics of Cost-Volume-Profit Analysis CM is used first to cover fixed expenses. Any remaining CM contributes to net operating income.

  4. Learning Objective 1 Explain how changes in activity affect contribution margin and net operating income.

  5. The Contribution Approach Sales, variable expenses, and contribution margin can alsobe expressed on a per unit basis. If RBC sells an additionalbicycle, $200 more in contribution margin will be generatedto cover fixed expenses and profit.

  6. To breakeven, RBC must generate $80,000in total CM each month to cover fixed costs. The Contribution Approach

  7. If RBC sells 400 unitsa month, it willbe operating at the break-even point. The Contribution Approach

  8. If RBC sells one more bike (401 bikes), net operating income will increase by $200. The Contribution Approach

  9. The Contribution Approach We do not need to prepare an income statement to estimate profits at a particular sales volume. Simply multiply the number of units sold above break-even by the contribution margin per unit. If RBC sells 430 bikes, its net operating income will be $6,000.

  10. Learning Objective 2 Prepare and interpreta cost-volume-profit(CVP) graph.

  11. CVP Relationships in Graphic Form The relationship among revenue, cost, profit and volumecan be expressed graphically by preparing a CVP graph.RBC developed contribution margin income statementsat 300, 400, and 500 units sold. We will use thisinformation to prepare the CVP graph.

  12. CVP Graph In a CVP graph, unit volume is usually represented on the horizontal (X) axis and dollars on the vertical (Y) axis. Dollars Units

  13. Fixed Expenses CVP Graph Dollars Units

  14. Total Expenses Fixed Expenses CVP Graph Dollars Units

  15. Total Sales Total Expenses Fixed Expenses CVP Graph Dollars Units

  16. Break-even point(400 units or $200,000 in sales) CVP Graph Profit Area Dollars Loss Area Units

  17. Learning Objective 3 Use the contribution margin ratio (CM ratio) to compute changes in contribution margin and net operating income resulting from changes in sales volume.

  18. The contribution margin ratio is:For Racing Bicycle Company the ratio is: Total CM Total sales CM Ratio = $80,000 $200,000 = 40% Contribution Margin Ratio Each $1.00 increase in sales results in a total contribution margin increase of 40¢.

  19. Or, in terms of units, the contribution margin ratiois: For Racing Bicycle Company the ratio is: Unit CM Unit selling price CM Ratio = $200 $500 = 40% Contribution Margin Ratio

  20. A $50,000 increase in sales revenue results in a $20,000 increase in CM. ($50,000 × 40% = $20,000) Contribution Margin Ratio

  21. Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. On average, 2,100 cups are sold each month. What is the CM Ratio for Coffee Klatch? a. 1.319 b. 0.758 c. 0.242 d. 4.139 Quick Check 

  22. Unit contribution margin Unit selling price CM Ratio = ($1.49-$0.36) $1.49 = $1.13 $1.49 = = 0.758 Quick Check  Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. On average, 2,100 cups are sold each month. What is the CM Ratio for Coffee Klatch? a. 1.319 b. 0.758 c. 0.242 d. 4.139

  23. Learning Objective 4 Show the effects on contribution margin of changes in variable costs, fixed costs, selling price, and volume.

  24. Changes in Fixed Costsand Sales Volume What is the profit impact if RBC can increase unit sales from 500 to 540 by increasing the monthly advertising budget by $10,000?

  25. Changes in Fixed Costsand Sales Volume $80,000 + $10,000 advertising = $90,000 Sales increased by $20,000, but netoperating income decreased by $2,000.

  26. The Shortcut Solution Changes in Fixed Costsand Sales Volume

  27. Changes in Variable Costsand Sales Volume What is the profit impact if RBC can use higher quality raw materials, thus, increasing variable costs per unit by $10, to generate an increase in unit sales from 500 to 580?

  28. Changes in Variable Costsand Sales Volume 580 units × $310 variable cost/unit = $179,800 Sales increase by $40,000, and netoperating income increases by $10,200.

  29. Change in Fixed Cost,Sales Price and Volume What is the profit impact if RBC:(1) cuts its selling price $20 per unit,(2) increases its advertising budget by $15,000 per month, and (3) increases unit sales from 500 to 650 units per month?

  30. Change in Fixed Cost,Sales Price and Volume Sales increase by $62,000, fixed costs increase by $15,000, and net operating income increases by $2,000.

  31. Change in Fixed Cost,Sales Price and Volume What is the profit impact if RBC: (1) pays a $15 sales commission per bike sold, instead of paying salespersons flat salaries that currently total $6,000 per month, and (2) increases unit sales from 500 to 575 bikes?

  32. Change in Fixed Cost,Sales Price and Volume Sales increase by $37,500, variable costs increase by $31,125, but fixed expenses decrease by $6,000.

  33. Change in Regular Sales Price If RBC has an opportunity to sell 150 bikes to a wholesaler without disturbing sales to other customers or fixed expenses, what price would it quote to the wholesaler if it wants to increase monthly profits by $3,000?

  34. Change in Regular Sales Price

  35. Learning Objective 5 Compute the break-even point in unit sales and dollar sales.

  36. Break-even analysis can be approached in two ways: Equation method Contribution margin method Break-Even Analysis

  37. At the break-even point profits equal zero Equation Method Profits = (Sales – Variable expenses) – Fixed expenses OR Sales = Variable expenses + Fixed expenses + Profits

  38. Here is the information from RBC: Break-Even Analysis

  39. Equation Method • We calculate the break-even point as follows: Sales = Variable expenses + Fixed expenses + Profits $500Q = $300Q + $80,000 +$0 Where: Q = Number of bikes sold $500 = Unit selling price $300 = Unit variable expense $80,000 = Total fixed expense

  40. Equation Method • We calculate the break-even point as follows: Sales = Variable expenses + Fixed expenses + Profits $500Q = $300Q + $80,000 + $0 $200Q = $80,000 Q = $80,000 ÷ $200 per bike Q = 400 bikes

  41. The equation can be modified to calculate the break-even point in sales dollars. Equation Method Sales = Variable expenses + Fixed expenses + Profits X = 0.60X + $80,000 +$0 Where: X = Totalsales dollars 0.60 = Variable expenses as a % of sales $80,000 = Total fixed expenses

  42. Equation Method • The equation can be modified to calculate the break-even point in sales dollars. Sales = Variable expenses + Fixed expenses + Profits X = 0.60X + $80,000 + $0 0.40X = $80,000 X = $80,000 ÷ 0.40 X = $200,000

  43. The contribution margin methodhas two key equations. Break-even point in units sold Fixed expenses CM per unit = Break-even point in total sales dollars Fixed expenses CM ratio = Contribution Margin Method

  44. $80,000 $200 per bike Break-even point in units sold Fixed expenses CM per unit = 400 bikes to breakeven = Break-even point in total sales dollars Fixed expenses CM ratio = $80,000 40% = $200,000 break-even sales Contribution Margin Method The contribution margin method canbe illustrated using data from RBC.

  45. Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. On average 2,100 cups are sold each month. What is the break-even sales in units? 872 cups b. 3,611 cups c. 1,200 cups d. 1,150 cups Quick Check 

  46. Fixed expenses Unit CM Break-even = $1,300 $1.49/cup - $0.36/cup = $1,300 $1.13/cup = = 1,150 cups Quick Check  Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. On average 2,100 cups are sold each month. What is the break-even sales in units? • 872 cups b. 3,611 cups c. 1,200 cups d. 1,150 cups

  47. Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. On average 2,100 cups are sold each month. What is the break-even sales in dollars? a. $1,300 b. $1,715 c. $1,788 d. $3,129 Quick Check 

  48. Fixed expenses CM Ratio Break-evensales = $1,300 0.758 = = $1,715 Quick Check  Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. On average 2,100 cups are sold each month. What is the break-even sales in dollars? a. $1,300 b. $1,715 c. $1,788 d. $3,129

  49. Learning Objective 6 Determine the level of sales needed to achieve a desired target profit.

  50. Target Profit Analysis The equation and contribution margin methods can be used to determine the sales volume needed to achieve a target profit. Suppose Racing Bicycle Company wants to know how many bikes must be sold to earn a profit of $100,000.

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