Cost-Volume-Profit-Analysis

Question 1

Contribution

Answer 1

Selling price - Variable Cost

Question 2

Contribution Margin (CM)

Answer 2

Amount remaining from sales revenue after variance expenses have been deducted.

Goes to cover fixed expenses, any remaining CM contributes to income.

Question 3

Contribution Income Statement

Answer 3

Sales - Variable expenses = Contribution Margin
Contribution Margin - Fixed expenses = Net income

Column for Total £ and £ Per Unit

eg 500 units
Total sales = £250,000
Per unit sales = £500
-
Total variable expenses = £150,000
per unit variable expenses = £300
=
Total CM = £100,000
Per unit CM = £200
-
Total fixed expenses = £80,000
=
Net income = £20,000

Question 4

Contribution Approach

Answer 4

Per unit
Sales - variable expenses =£X per unit
For each additional unit sold £X more in CM will help to cover fixed expenses and profit.
eg £200 per unit.

Must generate at least £(total fixed expenses) in total CM to break even.
eg £80,000

Net income = £0 from selling Y units - break even point.
Sell one additional unit (Y+1), net income increase by £X.
eg £0 for 400 units
401 units, increase by £200

Question 5

Break-even point

Answer 5

The point where total sales revenue = total expenses (variable and fixed).

The point where total contribution margin equals total fixed expenses.

Question 6

Contribution Margin Ration

Answer 6

CM Ratio = Contribution Margin/Sales (x100 to get %)

eg £200/£400=0.4x100=40%

Question 7

Changes in fixed costs and sales volume

Answer 7

e.g. £10,000 advertising adds onto fixed costs, sales increase to 540 units, good?
use VC per unit and sales per unit given from original statement to work out CM.
CM - new fixed costs (e.g. including advertising) to get net income.
eg 540 units x £500 = £270,000 total sales
540 units x £300 = £162,000 total variable expenses
total CM = £108,00
£108,000 - (£80,000+£10,000) = £18,000

Increased/decreased net income will tell you if idea is good or not.
e.g. decreased by £2,000

Look at net income as sales revenue may have increased but changes in cost could lead to a decrease in net income.
e.g. sales increased by £20,000 but net income decreased by £2,000.

Question 8

Changes in fixed costs and sales volume - the shortcut solution

Answer 8

Increase in CM - Increase in fixed cost expenses = Decrease in net income.

Increase in CM = increase in sales revenue x CM ratio
eg £20,000x0.4=£8,000

£8,000-£10,000 = -£2,000

Question 9

Break-even analysis

Answer 9

Two methods

1. Equation method.
2. Contribution margin method.

Question 10

Equation method

Answer 10

Profit = Sales - (Variable expenses + Fixed expenses)
or
Sales = Variable expenses + Fixed expenses + Profits

Question 11

Profit = ? at break-even point

Answer 11

0

Question 12

Equation method to find units for break-even point

Answer 12

Sales = Variable expenses + fixed expenses + profits

eg
£500Q = £300Q + £80,000 +£0
£200Q = £80,000
Q = 400 units

(Q - units
£500 - per unit sales
£300 - per unit vc
£80,000 - total fixed costs
£0 - profit (break-even))

Question 13

Equation method to find £ for break-even point

Answer 13

Sales = Variable expenses + Fixed expenses + Profits

eg
X = 0.60X + £80,000 + £0
0.40X = £80,000
X = £200,000

(X - total sales in £
0.60 - variable expenses as a percentage of sales (300/500)
£80,000 - total fixed expenses
£0 - Profit (break-even))

Question 14

Contribution margin method for units sold

Answer 14

Break-even point in units sold =
Fixed expenses/Unit contribution margin

eg £80,000/£200= 400 units

Question 15

Contribution margin method for total sales £

Answer 15

Break-even point in total sales £ =
Fixed Expenses/CM Ratio

eg
£80,000/0.4 = £200,000

Question 16

Break-even point graph

Answer 16

Cost £ (£000’s)on y axis, Volume (000’s) x axis
Total Cost = Total Sales Revenue is break-even point
Fixed cost - y = constant
Variable Costs and Total sales revenue start at origin
Fixed cost = Total cost at x = 0

Question 17

BEP

Answer 17

Break-even point

Question 18

CVP Graph

Answer 18

Income of costs on y axis, Number of units on x axis

Only Sales Revenue and Total Cost lines -
Intercept is the break-even point.
Area in between Sales Revenues and TC lines, to left of break-even point, where TC > Sales Revenue = Loss.
Area in between Sales Revenues and TC lines, to the right of the break-even point where Sales Revenue > TC = Profit.

Question 19

Target Profit Analysis

Answer 19

Can use CVP formula to determine sales volume needed to achieve a target net profit figure.

e.g. how many units need to be sold to earn £100,00 profit?

Question 20

CVP Equation (target profit analysis)

Answer 20

Sales = Variable expenses + Fixed expenses + Profits

eg
£500Q = £300Q + £80,000 + £100,000
£200Q = £180,000
Q = 900 units

Question 21

Contribution Margin Approach (target profit analysis)

Answer 21

Units sold to attain the target profit =
(Fixed Expenses + Target Profit)/Unit CM

eg
(£80,000+£100,000)/£200 = 900 units

Question 22

Equation Summary

Answer 22

Sales = (FC + target profit)/CM per unit

CM = Sales - VC

Break-even units = FC/CM per unit

Break-even total sales £ = FC/CM ratio

CM ratio = CM/Sales

Total Sales = Total VC + FC + Profits
where total sales = break-even points in units x sales per unit, total vc = break-even points in units x vc per unit
Profit = £0

Total sales £X = VC + FC + Profits
where X = break-even point in £,
VC = vc/sales x break-even point in £
Profit = £0

Question 23

Margin of Safety

Answer 23

Excess of budgeted (or actual) sales over the break-even volume of sales.

The amount by which sales can drop before losses begin to be incurred.

Margin of safety = Total actual sales - Total Break-even sales

Question 24

Margin of safety % of sales

Answer 24

Margin of safety/Total actual sales

Question 25

Operating leverage

Answer 25

Measure of how sensitive net income is to percentage changed in sales.

Degree of operating leverage =
Contribution margin/Net income

With high leverage, a small % increase in sales can produce a much larger % increase in net income.

% increase in sales x Degree of operating leverage =
% increase in profits

Question 26

Assumptions of CVP

Answer 26

Selling price is constant throughout the entire relevant range.

Costs are linear throughout the entire relevant range.

In multi-product companies, the sales mix is constant.

In manufacturing companies, inventories do not change (units produced = units sold).

Question 27

Relevant Range

Answer 27

Volume range within the which the actual operations are likely to occur.