MA Week 4 Flashcards
What is the importance of Relevant Range?
- range within which can carry out CVP analysis
- anything outside won’t work for us
- has to be a STRAIGHT line
High-low method
y = a + bx
used to estimate the fixed & variable cost elements of a mixed cost
To calculate b, use HIGHEST & LOWEST points (= variable cost per unit)
What are the 3 components of CVP analysis?
Fixed costs, variable costs, revenue/quantity
Breakeven point in units
Breakeven point in £
*no profits. Total cost = Total revenue
Fixed cost / Contribution per unit
Fixed cost / CMR
Contribution Margin Ratio (CMR)
aka C/S ratio
Contribution per unit / Selling price per unit
Sales in units required to achieve Target Profit (TP)
Sales in £ required to achieve Target Profit (TP)
FC + TP // Contribution per unit
FC + TP // CMR
Margin of safety (units). Can also be in £ or %
Higher MoS means…
Budgeted sales units - Breakeven sales units
MoS in % = (MoS units / Budgeted sales units) * 100%
Margin of safety can be used as a partial measure of risk. Generally, higher margin of safety, higher operating profit
Operating leverage + what does it measure?
∴ If we want to produce more profit, it makes sense to go for INVESTMENT in businesses, ie. high FC for initial investment, which is good for later
= Contribution / Operating profit
Measures operating risk
- Can do sensitivity analysis to see what impact lower than expected or higher than expected sales can have on the overall profit.
- If revenue increases by 1%, operating profit will increase by _%
Highly-leveraged operations: high FC compared to VC, so ratio larger.
- Small changes in sales volume (1%) result in large changes in operating income (1% * operating leverage multiple)
- High FC can be risky business b/c operating profit is highly variable. More risky but also potentially more return after BE is reached
- Lower FC, less risky - but also less steep increase in revenue once BE is reached
5 limitations of CVP analysis
- expects LINEAR cost behaviour (ref. to relevant range)
- expects as if operating efficiencies haven’t changed (relevant range)
- SELLING PRICE might change; charge diff. clients diff. amounts
- ignores TIME VALUE OF MONEY & inflation, therefore a short term decision tool
- if >1 one product produced, may be difficult to APPORTION FC between diff. products
What do we do if business has scarce resources?
- Work out Contribution per limiting factor
- Rank products
- Go for product w/ Highest contribution per unit, then 2nd highest…
Scarce resource - we do not have supply of to undertake every opportunity to make additional contribution
2 methods to accomplish same job - which to choose?
Labour-intensive (high VC) vs Machine-intensive (high FC)
- Calculate quantity to produce at which both cost the same
FC1 + (VC1 * Q) = FC2 + (VC2 * Q)
so, Q = FC1 - FC2 // VC2 - VC1 - If we project to produce more than that quantity, it makes sense to invest (in machines) & increase FC, then increase contribution and increase profit. {b/c VC lower}
8 assumptions to the accountants’ approach to breakeven analysis
- Fixed costs are stable over the relevant range of activity
- The analysis applies only to the RELEVANT RANGE
- The analysis applies only to a SHORT-TERM time horizon
- Total costs and total revenue are LINEAR functions of output
- All other variables remain constant
- A single product or constant sales mix
- Costs can be ACCURATELY DIVIDED into their fixed and variable elements
- Variable costs change in direct proportion to activity
2 methods to accomplish same job - which is more viable? (FC vs VC)
1 is machine-intensive (high fixed costs), another is labour-intensive (high variable costs). At what quantity will both COST the same?
ie. calculate FC1 + VC1(Q) = FC2 + VC2(Q)
- If we project to produce > that quantity Q, it makes sense to invest (in machines) & increase FC, then increase contribution and increase profit {b/c VC lower}.
- Also consider other financial and NON-FINANCIAL aspects before taking one course of action
eg. life of the saws, staff morale. Humans could be moody and have their lazy days, avoiding physical work etc.!
