Lecture 3 - Cost-Volume Profit Analysis Flashcards
What is ‘Cost-Volume Profit Analysis’?
A systematic method for examining the relationship between changes in volume of output and changes in total sales revenue, expenses and net profit.
Over what time frame is Cost-Volume Profit Analysis carried out?
Usually a year or less
On a break-even graph, what variable is held on the Y-axis?
Costs
What does the accountants view of ‘break-even analysis’ hold to be true? And is this correct?
There is a linear relationship between TR and TC.
In reality, this is not true however in the ‘Relevant range’ it usually does not differ substantially.
What does the term ‘Relevant Range’ mean? And What is pressumed safe to assume?
The ‘Relevant Range’ is the output range in which a firm expects to be operating within a short-period planning horizon.
It is safe to assume that TR and TC have a linear relationship.
What is the ‘Economists View’ of break-even analysis?
TR and TC aren’t related linearly. Firms may have to expand FC as they grow and sell more.
Example:
A firm making cars cannot sell 1,000,000 a month if they are operating out of a garage, they will have to move to a bigger factory and therefore FC will increase.
What does the ‘Economists View ‘ of break-even analysis lead to?
Two break even points, One on the way up where TC first meets TR and one on the way down when TR tails off and TC increase.
What is a ‘Profit-Volume Chart’?
The Profit-Volume chart plots the total profit line and from there calculates the break even point.
Where is the break-even point on a Profit-Volume Chart?
Where profit intercepts the 0 unit line
In a ‘Profit-Volume’ graph, what do the areas above and below the X-axis represent?
Above = Profit Area Below = Loss Area
What are the Five key-assumptions for CVP analysis?
1) All other variables remain the same.
2) The product mix remains the same.
3) TC and TR are linear functions of output.
4) Only the Relevant range is important.
5) Costs can be split into fixed and variable costs.
At the Break-Even point, … is equal to …
TC and TR
What is the Break-Even Analysis formula?
BEP = FC/(SR/VC)
What is ‘Contribution’?
Contribution is the excess revenue left over that contributes to the payment of FCs after VCs have been deducted
When contribution is equal to FC…
The break-even point has been achieved
When you know the ‘Contribution’ of a product, how do you then calculate the no. of units needed to break even?
N0. of units needed = FC/Contribution per unit
What is the formula for calculating the ‘break-event point’ given the FC, Target Profit and Contribution?
Number of units needed = (FC+Target Profit)/ Contribution per unit