Week 10 - Cost Volume Profit Analysis 2.1

Question 1

What formula can we use to determine the sales volume needed to achieve a target net profit figure?

Answer 1

Sales (per unit) = VC (per unit) + FC + net target profit figure

Question 2

What formula can we use to determine the number of items that must be sold to achieve a target profit e.g £100,000?

Answer 2

Units sold to attain profit = FC + target profit / contribution per unit

Question 3

Define the margin of safety

Answer 3

The amount by which sales can drop before losses begin to be incurred

Question 4

What is the formula for the margin of safety?

Answer 4

Margin of safety = Total sales - break even sales
or
Margin of safety = current level - break even level

Question 5

How can we make the margin of safety a percentage?

Answer 5

Divide the margin of safety by the actual sales in units or £, then x 100
e.g
margin of safety sales / actual sales

Question 6

What is the operating leverage?

Answer 6

A measure of how sensitive net income is to percentage changes in sales

Question 7

What is the formula for operating leverage?

Answer 7

Degree of operating leverage = contribution / net income

Question 8

With high leverage, a small percentage increase in sales can produce…

Answer 8

A much larger percentage increase in net income

Question 9

How do you find what your % increase in profits would be by using operating leverage?

Answer 9

% Increase in profits = operating leverage x % increase in sales

Question 10

What are our assumptions of CVP analysis - limitations of application?

Answer 10

1) we assume selling price is constant throughout entire relevant range
2) costs are linear throughout entire relevant range
3) in multi-product companies the sales mix is constant
4) in manufacturing companies, inventories do not change (units produced = units sold)