Chapter 5: Cost volume profit analysis Flashcards
What is breakeven (Cost volume profit CVP) analysis?
Study of future profits of changes in fixed & variable costs, sales price, quantity & mix
What if analysis
Considers the impact on the budgeted profit of changes in various factors
What is the breakeven point
level of activity where there is neither profit or loss
What is the calculation for break even points in units?
Fixed cost/ Contribution per unit
What is the calculation for level of activity to earn a required profit
Required profit+ fixed costs/ contribution per unit
What is the calculation for margin of safety (%)?
((Budgeted sales- breakeven sales)/ budgeted sales)*100
What is the calculation for contribution / sales (C/S) ratio?
Contribution/ sales
What is the calculation for breakeven point in sales revenue?
Fixed costs/ C/S ratio
What is the calculation for sales revenue to earn a target profit?
Required profit + fixed costs / C/S ratio
aspects of a breakeven chart
X axis: level of activity e.g no of units
Y axis: costs & revenue
2 lines drawn on chart : Total cost & sales revenue
Margin of safety - X axis between BE point & forecast sales level
Variable cost - Y axis between total cost & Fixed cost
Fixed cost line on the y axis
Above BE diff between Sales rev & total cost = profit and below = loss
can fall under margin of safety without making a loss
Steps to draw a breakeven chart
Step 1: Select scales of axis. X = largest no of units forecast. Y= monthly sales revenue max
Step 2: Draw & label fixed cost line
Step 3: Draw& label total cost line (Variable costs total + fixed for forecasted volumes)
Step 4: Draw & label sales revenue line (starts at 0 to max)
Step 5: Marked required info on chart. Check BE point is correct using breakeven point in units formula
Calculate Margin of safety %
Problem with normal BE chart
Can’t read contribution directly
What is the difference between a normal BE chart & contribution BE chart
Contribution BE chart has a line for variable costs
Calculate contribution diff in sales revenue for forecast vols & variable cost
Fixed cost= Total cost for forecast vols - variable cost
What’s a profit- volume chart
The BE cross the X across
Plot the profit/loss line for each level of activity
AKA profit- volume graph or a contribution - volume graph
What is the advantage of a profit-volume chart
depict the effect on profit & BE point in changes to the variables
What does CVP analysis assume if it sells a range of products
Sales in accordance to a pre-determined sales mix (average revs & variable costs assuming the mix remains constant)
Calculation for BE point in a multi- product firm
Fixed costs/ weighted average contribution to sales ratio
weighted average contribution to sales ratio= Total contribution/ total sales
Calculation for sales revenue required to a target profit
(Fixed costs + required profit)/ weighted average C/S ratio
Not always achievable
Market dynamic influences the selling price not the seller
Steps to draw the multi-product profit- volume graph
Step 1: Calc C/S ratio of each product sold, rank in order of profitability (hgihest c/s ratio ranked first)
Step 2: Draw graph. X axis= cum sales. Y= profit earned. V on x axis = total sales. K= at 0 output how much fixed costs are
Step 3: Draw a line from K to M where M is the largest profit product. Slope of the line is the contribution per unit on sales of that product
Step 4: Draw line M to N where N is the profit earned by 2nd product , lower contribution than 1st product and N to J - profit earned from smallest profitable product
Step 5: Draw a line joining K and J (average profitability of 3 products) assumed to be sold in the same product mix
What 2 lines are on the multi-product profit- volume graph
1 straight line = constant mix between products assumed
1 bow shaped line = how individual products contribute
What are the benefits of of plotting product individually in decision making process
1) Improve overall profitability = increase in sales of product with highest C/S ratio
2) helps decide what products are continued/abandoned
3) helps management focus on the price of products and whether some prices should be raised to improve individuals product’s C/S ratio
4) clarifies what changes in selling prices & sales volumes have on BE points and profits
What are the top 5 limitations to BE analysis
1) behaviour of total cost & revenue is reliably determined & linear over relevant range
2)all costs divided into fixed& variable
3) total fixed costs are constant over volume range of CVP analysis
4) Variable costs directly proportionate to volume over relevant range
5) selling prices are unchanged
What are the further 6 limitations to BE analysis
6) prices of production unchanged (e.g material/labour)
7) Efficiency & productivity= unchanged
8) 1 product or mix is maintained
9) Rev & costs compared on a single activity basis
10) volume only relevant factor affecting cost-not realistic assumption
11) volume of production= volume of sales - it’s market dependent . What’s produced isn’t always sold
