Cost-Volume-Profit (CVP) Relationships Flashcards
What is CVP?
Cost-volume-profit: The interrelationship between the key elements of the management accounts (cost, production levels, sales volumes and revenue) and profit.
What is the 2 main models for conducting a CVP analysis?
The economist’s model
The accountant’s model
What does the economist’s model recognise?
That the rate of change in total cost and total revenue is unlikely to remain constant as volumes change.
Initially small reductions in selling price result in relatively large increases in sales volumes.
What does the accountant’s model assume?
That as volume increase, the rate of change in both total revenue and total costs is constant (linear relationship).
Selling price per unit remains fixed.
Which model is easier to apply?
The accountant’s model
What is the most common application of CVP?
To perform a break-even analysis.
What is the break-even point?
The level of activity where neither a profit or loss is made.
What are the 3 methods to calculate the break-even point?
The profit formula.
The contribution margin formula.
The break-even chart
What is the profit formula?
Difference between Revenue and cost.
CVP assumes volume is the only revenue and cost driver - therefore dependent on number of units sold.
Total costs are split between fixed and variable.
What formula is used for the profit formula?
P = SPx - (FC + VCx)
P: Profit SP: Selling price per unit x: number of units sold FC: Total Fixed Costs per annum VC: Variable costs per unit
What is the contribution margin formula?
Contribution is calculated as selling price less VARIABLE cost - indicates how much each unit contributes toward covering fixed costs.
Therefore where total contribution = FIXED costs, the break-even point is reached.
What formula is used for the contribution margin formula?
Break-even units = total FIXED costs / contribution PER UNIT.
Alternatively
Break-even sales revenue = total FIXED costs / contribution margin ratio.
Where contribution margin ratio = contribution / selling price
What is a sensitivity analysis?
It indicates how sensitive one value is to changes in another variable in the same modal
What is CVP also used for in addition to break-even?
Performing sensitivity analysis
Can profit be calculated for any level of activity?
Yes, if the selling price, fixed - and variable costs are given.
What is the margin of safety?
A measure of the extent to which the current level of sales can drop before a loss incur.
Provides useful indicator for the amount of risk associated with a product.
How do a higher margin of safety affect sales?
The higher the MOS, the greater the level of sales can drop before a loss.
When is a margin of safety useful?
When managers need to consider the impact of new competition.
Where there is a reduction in demands.
Uncertainty surrounding the exact level of expected sales (new product).
How can the margin of safety be calculated?
As a percentage.
Total sales value or
The number of units
Margin of safety formulae
% = (current sales - break-even sales) / current sales x 100
Units = current sales volume - break-even sales volume
Sales value = current sales - break-even sales
OR
Sales value = MOS units x selling price per unit
When can these formulas be used?
Only in scenarios where there is 1 product sold or service being delivered
What is common fixed costs?
When companies sell multiple products and the fixed costs are not directly attributable to the products.
How can common fixed costs be treated?
Allocate it to the products.
Ignore these.
Use the sales mix (most common).
What is an organisation’s sales mix?
The proportion in which products are sold.
A weighted-average unit contribution margin is calculated.
