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
How do you calculate the price at which a product should be sold given the FC, VC, Target Profit and the Volume of units sold?
Selling Price = (FC+(VC*n)+Tprofit)/n
What is the ‘Profit-Volume Ratio’?
The Profit-Volume Ratio, represents the proportion of £1 sales which is contribution
What is the formula for calculating the ‘Profit-Volume Ratio ‘?
Contribution/SP
In what formula can the ‘Profit-Volume Ratio’ be used to calculate the break-even point?
BEP = FC/p-v Ratio
What is the ‘Margin of Safety’ (MOS)?
The margin of safety indicates by how much sales can decrease before the company suffers a loss
How is the ‘Margin of Safety’ calculated?
MOS (%) = (Expected sales - Break-Even sales)x100/Expected sales
What is ‘Operating Leverage’? And Why is it useful?
‘Operating Leverage’ is simply the ratio of contribution to profits.
It can help to compare labour and capital intensive firms.
What do a High and a Low operating leverage mean?
High = Firm is sensitive to sales due to greater FC.
Low = Firms aren’t as sensitive to sale due to their lower FC.
What is the formula for calculating ‘Operating Leverage’?
Total contribution/Profit
The accountants view of break even analysis assumes that…
TC and TR are linear functions of volume
What are the two justifications of the accountants view of break even analysis?
- It allows a decision to be made.
2. It is relevant to a certain degree (within the relevant range)
What is meant by the term ‘relevant range’?
The relevant range refers to the output range that at which a firm expected to be operating within the short-term planning horizon.
Within the relevant range it is safe to assume that TC and TR are linear
Within the relevant range, it is safe to assume that…
TC and TR are linear functions of output
The economists view of break even makes a point in relation to revenue, what is it?
TR cannot increase forever at he same rate, to sell more firms must lower their price at some point.
Making decisions under the economists view is hard because of…
There being 2 different break-even points
On a profit-volume chart, what is held on the vertical rand horizontal axis?
Y axis = Profit
X axis = Volume of activity
As well as referring to the output range a firm expects to be operating within, the relevant range also refers to…
The output levels a firm has experience of operating at and therefore has cost information for
The Break even point in terms of units needed is calculated using what formula?
BEP = FC/ (SR per unit - VC per unit)
What is meant by the term contribution?
The excess revenue left over after VC have been deducted that contributes to covering FCs
What is the formula used to calculate the number of units needed to break even along with a target profit?
BEP = FC+Target Profit/ Contribution
How to calculate at what price a product should be sold to break even?
Selling price = (FC+ (VC*n)+target profit)/n
What is operating leverage useful for?
Comparing Capital and Labour intensive firms
Drawing the VC line on top of the FC line gives the…
Total Cost Line
At zero output, TC is equal to what?
FC
Where is the Break-Even point on a normal Break-even graph?
The interception of Total Revenue and Total Cost
On a graph with Semi-Variable costs, the relevant range lies…
Between the steps
