Projection and Forecasting Techniques Pt. 2 Flashcards
What is cost-volume-profit (CVP) analysis?
it is used by managers to forecast profits at different levels of sales and production volume; the point at which revenues equal total costs is called the breakeven point; CVP analysis is synonymous with breakeven analysis
although CVP can be performed for more than one product, in its simplest form, the model assumes that the product mix remains constant
general assumptions: all costs can be separated into either variable or fixed, volume is the only relevant factor, all costs behave in a linear fashion in relation to production volume, cost behaviors are anticipated to remain constant over the relevant range of production volume, and costs show greater variability over time
absorption approach vs contribution approach
absorption - required for financial reporting under GAAP and does not segregate fixed and variable costs
formula: revenue - COGS = gross margin
gross margin - op exp = net income
contribution - does not represent GAAP, but it is extremely useful for internal decision making
formula: revenue - variable costs = CM
CM - fixed costs = net income
contribution margin ratio = contribution margin / revenue
What makes up variable and fixed costs?
VC: DM, DL, variable MOH, shipping and packaging, and variable selling expenses
FC: fixed MOH, fixed selling, and most general and admin expenses
the difference between the absorption and contribution approaches is the treatment of fixed factory overhead; selling, general, and admin expenses are period costs under both methods
Fact: if all production is sold every period, then both methods produce the same operating income figures, but if the number of units sold is more or less than the number of units produced, the operating income figures will be different
no change in inventory: absorption NI = variable NI
increase in inventory (production greater than sales): absorption NI > variable NI
decrease in inventory (sales are greater than production): absorption NI < variable NI
What is breakeven analysis?
it determines the sales required (in dollars or units) to achieve zero profit or loss from operations; in determining the amount in revenues required to break even, management must estimate both fixed costs overall and variable costs on a per-unit basis
the contribution approach to the income statement makes it easy to calculate the breakeven point in either units or dollars
breakeven point in units = total fixed costs / contribution margin per unit
there are two approaches to computing breakeven in sales dollars:
breakeven point in dollars = unit price * breakeven point (in units)
OR
breakeven point in dollars = total fixed costs / contribution margin ratio
Fact: breakeven analysis can be extended to calculate the unit sales or sales dollars required to produce a targeted profit
although profit figures are most relevant on an after-tax basis, the amount that must be added to the breakeven computation must be a before-tax profit amount to maintain consistency with the pretax figures used in the calculation
below are the formulas used to obtain a desired profit in units or dollars:
sales (units) = (fixed costs + pretax profit) / contribution margin per unit
sales (dollars) = variable costs + fixed costs + pretax profit
OR
sales (dollars) = (fixed cost + pretax profit) / contribution margin ratio
Fact: after breakeven has been achieved, each additional unit sold will increase net income by the amount of the contribution margin per unit
this analysis also may be used to derive a per-unit selling price necessary to cover all costs and the desired pretax profit given a specific volume limit
sales price per unit = (fixed costs + variable costs + pretax profit) / number of units sold
What is the margin of safety?
the excess of sales over breakeven sales and generally is expressed as either dollars or a percentage
margin of safety (in dollars) = total sales (in dollars) - breakeven sales (in dollars)
margin of safety (percentage) = margin of safety in dollars / total sales
What is target costing?
a technique used to establish the product cost allowed to ensure both profitability per unit and total sales volume
the concept of target costing uses the selling price of the product to determine the production costs to be allowed
as competition sets prices, any change in price could easily cause customer defection; target costing is the first step in establishing cost controls to ensure ongoing profitability
target cost = market price - required profit
