Topic 3 CVP Flashcards
what is the study of CVP?
The effects on future profit of charges in fixed costs, variable cost, sales price, quantity and mix
What is the break even point?
the level of activity at which there is neither a profit or a loss for a a company.
draw an example of a cost / activity chart and explain it
Topic 3 notes graph. ( Draw it out as appendix)
The further the volume of activity is below BEP…
The higher the loss
the further the volume of activity above BEP…
the higher the profit
what is the formula for total sales revenue
total sales revenue = fixed costs + variable costs
what is the equation for the number of units of output at BEP
Number of units of output a BEP = fixed cost / (sales revenue per unit - variable cost per unit)
REMEMBER BEP MUST BE EXPRESSED WITH RESPECT TO A PERIOD OF TIME
What is meant by contribution?
Contribution = sales revenue per unit - variable
It contributes to the fixed cost and if there is any excess, it then contributes to profit and any deficit or loss.
what is the contribution margin ratio?
The contribution from an activity expressed as a percentage of the sales revenue
contribution margin ratio = contribution / sales revenue (x100)
what is the Margin of safety?
the extent to which planned volume of output or sales lies above the BEP; can be used as a potential measure of risk (difference between expected volume of sales and BEP)
margin of safety = (expected safety - breakeven sales) / expected sales
how can you calculate the volume of activity required to achieve a particular level of profit?
Required number of units for a particular profit level = (fixed cost + target profit) / (sales revenue per unit - variable cost per unit)
what is operating gearing?
relationship between fixed cost and variable costs; an activity with a high fixed cost compared to total variable cost, at its normal level of activity is said to have a high operating gearing.
what is operating gearing / leverage?
(contribution / profit)
increasing this makes profit more sensitive to changes in the volume of activity.
draw an example of a profit volume chart
topic 3 notes (draw out as appendix)
what are three weaknesses of the break even analysis?
1) non linear relationships
- in real life the total variable and revenue lines not likely to be straight, however minor variations in them are unlikely to be really significant
2) stepped fixed costs
- means in practise great care must be taken when considering fixed costs, problem amplified when many activities involve different types of fixed costs which are likely to have steps at different points, like rent
3) multi product business
- Most businesses; additional sales of one product may affect sales of another one of the businesses products. Also creates an issue of identifying the fixed cost associated with a particular product.
there are ways off apportioning the fixed cost of the factory between products, but they tend to be arbitrary (random), therefore undermining the value of break even analysis.
what is the contribution / sales ratio?
a measure of how much contribution is earned from each £1 of sales.
CS Ratio = contribution per unit / selling price per unit (x100)
summery slide on topic notes page 4 draw out
.
For multiproduct CVP, why does the normal BEP approach not work?
how can break even calculations happen instead?
As individual products have different selling prices and contribution. instead: - contribution per mix of product - weighted average contribution per unit - weighted average C/S ratio
What are the 5 steps of contribution per mix of product?
1) calculate contribution per unit
2) calculate contribution per mix
3) calculate BEP in number of mixed
4) Calculate BEP in number of units of each product
5) Calculate the BEP in terms of revenue
what is the key consideration for one off contract decisions?
Spare capacity - measures the extent to which an industry or economy is operating below the maximum sustainable level of production - there are spare factor resources of land, labour and capital.
if spare capacity exists - relevant cost of making product in-house = variable cost of internal manufacture plus any fixed costs directly related to that product
no spare capacity - relevant cost of making the product in-house = variable cost of internal manufacture plus any fixed costs plus the opportunity cost of internal manufacture.
what is a scarce resource? (limiting factors/resource constraints/bottleneck constraints)
When there is fewer than needed to satisfy human wants and needs. for example labour, materials, storage capacity
what are the implications of scarce resources?
short term decisions;
- maximise short term benefit from using limited resources
long term decisions;
- seek to invest in extra capacity to maximise positive opportunities
what is the 5 step approach to limiting factor analysis?
1) identify the scarce resource
2) calculate the contribution per unit of each product
3) calculate the contribution per unit of scarce resource
4) rank the products in order of the contribution per unit of scarce resource
5) allocate scarce resource using this ranking
REMEMBER: if there are two or more limiting factors, CVP cannot be used
- linear programming is normally used to solve this sort of problem, can be done using algebra or computer program but not required for exam.
what is meant by make or buy decisions?
Businesses are frequently confronted with the need to decide whether to produce the product or service they sell themselves, or to buy it from some other business.
virtually, any part / component or service that is required in production of the main product or service, or the main product or service itself, could be the subject of a make or buy decision.
what is it called when you obtain services or products from a subcontractor?
Outsourcing
what is meant by marginal analysis?
Marginal analysis is an examination of the additional benefits of an activity compared to the additional costs incurred by that same activity. Companies use marginal analysis as a decision-making tool to help them maximize their potential profits
when may marginal analysis be used?
four key areas of decision making:
1) pricing/assessing opportunities to enter contracts
2) determining the most efficient use of scarce resource
3) make or buy decisions
4) closing or continuation decisions
what is meant by a closing or continuation decision?
it can be quite common for a business to produce separate financial statements for each department / section / store, to try and asses their relative performance. marginal analysis can help to decide the way to respond for each
