Chaper 8 - Cost Volume Profity Analsis Flashcards
What is cost volume profit analysis
Cost volume profit analysis considers how costs and profits change with the changes in the volume of level an activity
Things to consider with cost volume profit analysis are
Breakeven
Margin of safety
Contribution to sales ratio
What is the break even equation for volume
break even volume = fixed costs / contribution
Breakeven is the level of activity which gives rise to 0 profits. Since profit is the difference between total contribution and fix costs break Ethan is where the total contribution equals total fix costs
What is the margin of safety formula
The margin of safety measures the percentage for M budgeted sales that can be allowed before break even is reached and it is useful in identifying how big a problem any inaccuracy in the budget to sales is likely to be
Margin of safety = (budgeted sales - break even) / budgeted sales x 100%
For example if we know that budgeted sales is 300 fixed costs 1000 selling price is $6 and variable costs $2 then we know the contribution is $4 We also know that break even need to equal fixed overheads and therefore the breakeven volume is 250 units therefore the margin of safety is 300 units -250 units equals 50 units divided by 300 units which equals 16.7% which is the margin of safety
What is the contribution to sales ratio or the CS ratio
C/S ratio = contribution in $ / Sales in $
Since the contribution and the sales both very linearly with the volume the CS ratio will remain constant nose also this is sometimes called the profit to volume ratio
For example if we know sales is $6 variable cost $2 then we know the contribution is $4 and the 4/6 = 0.67. Why is this useful well we know that regardless of how many we sell the contribution will always be .67 of the sales
What do the break even chart and profit value chart look like
See photos taken in the notes on my phone
What is multiproduct cost volume profit analysis
In practice the company is likely to make several products each with different CS ratios. They are still likely to be interested in the breakeven sales revenue (in order to cover the fixed overheads) with existence of several products are less certain and is all we can really do is calculate break even on the assumption that the mix of products remains as per the budgeted mix even if total sales are lower
However as will be illustrated in the following example the companies could reach the break even position sooner if they were to sell the products with the highest CS ratios first
How to calculate the average CS ratio for multiple Products in cost volume profit analysis
Unlike with singular CS ratios with multiple products for example 3 products we may need to find the average CS ratio. However we are not able to find the individual CS ratios Add them together and divide by their number Because this doesn’t take into consideration sales units as one product could sell a lot more than the other so they are not equal.
To calculate the CS ratio for multiple products We first need to find the total revenue for each products and also the total contribution for each product and then as usual divide contribution by the revenue as this would capture everything
What is one useful thing about CS ratios (contribution to sales ratio
By finding the percentage of contribution to sales means that as it is linear we are able to find the revenue amount For any position. Four example if we knew that breakeven was $10,000 and the CS Ratio was 30% then to find the re Eunice to break even we divide 10,000/30 x 100%
What are the limitations of CVP analysis cost volume profit analysis
The selling price per unit is assumed to remain constant at all levels of activity
The variable cost per unit is assumed to remain constant as all levels of activity
It’s a shame that the fix costs remain constant
It’s assumed the level of production is equal to the level of sales(no changes in inventory)
