Week 7 - Cost Behaviour and CVP Analysis

Question 1

What is cost-volume-profit (CVP) analysis?

Answer 1

• CVP examines the relationship between changes in activity and changes in total sales revenue, costs and profit
• It examines the nature of this relationship in the short run:
• Output is restricted to current operating capacity
• Short run profit is most influenced

Question 2

What concerns CVP analysis?

Answer 2

• Break even point
• Sales volume and cost of sales
• Mrgin of safety

Question 3

Amazon example of CVP (3)

Answer 3

• Amazon were deciding between two tactics for growing sales and profits
• The first approach was to invest in TV advertising and second approach was to offer free shipping on large orders
• At each stage Amazon used CVP analysis to determine whether the extra volume from liberising the free shipping offering more than offset the associated increase in shipping costs

Question 4

Definitions of break even (3)

Answer 4

• Point where total sale revenue = total costs
• Point where total contribution margin = total fixed costs
• Point where neither a profit nor a loss is made

Question 5

Two methods of break even analysis

Answer 5

• Numerical analysis
• Graphical

Question 6

CVP Analysis assumptions (7)

Answer 6

• Total costs and total revenues are linear functions of output
• All other variables remain constant
• Costs can be accurately divided into their fixed & variable elements
• Analysis applies only in the relevant range
• Analysis applies only in the short run
• One product firms or a constant sales mix
• Units made = units sold

Question 7

Interpret Curvilinear CVP relationships (3)

Answer 7

A - Cost increase as you are new and building a relationship with supplier

B - Build trust with supplier so costs start to flatten out

C - Increase in business growth will increase costs

Question 8

Contribution margin/profit-volume ratio formula

Answer 8

Contribution / sales x 100

Question 9

Break even point (BEP) in units formula

Answer 9

Fixed costs / contribution per unit

Question 10

Volume needed to earn a target profit formula

Answer 10

Fixed costs + target profit / unit contribution

Question 11

Formula for margin of safety

Answer 11

Expected sales (or budgeted sales) - break even sales / expected sales (or budgeted sales) x 100

Question 12

What is margin of safety? (3)

Answer 12

• Margin of safety denotes the excess of budgeted (or expected) sales volume over the break-even volume of sales
• It tells us how risky out business model is; we ideally want the margin of safety to be as big as possible
• So (in other words) is the amount by which sales can drop before losses begin to be incurred

Question 13

Contribution per unit formula

Answer 13

Contribution per unit = selling price - variable cost per unit

Question 14

Formula for target profit (for certain number of units sold)

Answer 14

Fixed costs + target profit / unit contribution

Question 15

Formula for profit that includes contribution and fixed costs

Answer 15

Profit = contribution - fixed costs

Question 16

Draw a CVP Graph

Answer 16

Question 17

4 Ways business can increase profit

Answer 17

• Increase the selling price per unit
• Decrease the variable cost per unit
• Increase volumes
• Reduced the fixed cost base