CVP Analysis

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Uses of the Contribution Format Uses o t e Co t but o o at
Th t ib ti i t t t f t i d Th t ib ti i t t t f t i d The contribution income statement format is used The contribution income statement format is used
as an internal planning and decision making tool. as an internal planning and decision making tool.
Thi h i f l f Thi h i f l f This approach is useful for: This approach is useful for:
1. 1. Cost Cost--volume volume--profit analysis profit analysis p y p y
2. 2. Budgeting Budgeting
3. 3. Segmented reporting of profit Segmented reporting of profit data data
44 Special decisions s ch as pricing and make Special decisions s ch as pricing and make or or 4. 4. Special decisions such as pricing and make Special decisions such as pricing and make--or or--
buy buy analysis analysis
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The Contribution Format
Used primarily for Used primarily for
external reporting external reporting
Used primarily by Used primarily by
management management external reporting. external reporting. management. management.
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The Contribution Format
Total Uni t Total Uni t
Sal es Revenue 100,000 $ 50 $
Less: Vari abl e costs 60 000 30 Less: Vari abl e costs 60,000 30
Contri buti on margi n 40,000 $ 20 $
Less: Fi xed costs 30,000
Net operati ng i ncome 10,000 $
Th t ib ti i f t h i Th t ib ti i f t h i The contribution margin format emphasizes The contribution margin format emphasizes
cost behavior. Contribution margin covers fixed cost behavior. Contribution margin covers fixed
t d id f i t d id f i costs and provides for income. costs and provides for income.
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3-2
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CVP Relationships in Graphic Form
The relationship among revenue, cost, profit and
l b d hi ll b i volume can be expressed graphically by preparing
a CVP graph. Racing developed contribution
margin income statements at 300, 400, and 500 margin income statements at 300, 400, and 500
units sold. We will use this information to prepare
the CVP graph.
Income
300 uni ts
Income
400 uni ts
Income
500 uni ts
$ $ $ Sal es 150,000 $ 200,000 $ 250,000 $
Less: vari abl e expenses 90,000 120,000 150,000
Contri buti on margi n 60,000 $ 80,000 $ 100,000 $ g
Less: fi xed expenses 80,000 80,000 80,000
Net operati ng i ncome (20,000) $ - $ 20,000 $
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CVP Graph
4 0 000
350 000
400,000
450,000
Total Sales
250,000
300,000
350,000
Total Expenses
Total Sales
150,000
200,000
,
Fixed Expenses
Total Expenses
50,000
100,000
-
- 100 200 300 400 500 600 700 800
U it Units
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CVP Graph
4 0 000
350 000
400,000
450,000
Break Break--even point even point
(400 units or $200,000 in sales) (400 units or $200,000 in sales)
250,000
300,000
350,000
150,000
200,000
,
50,000
100,000
-
- 100 200 300 400 500 600 700 800
U it Units
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Contribution Margin Ratio
The contribution margin ratio is:
Total CM
CM R ti
For Racing Bicycle Company the ratio is:
Total CM
Total sales
CM Ratio =
For Racing Bicycle Company the ratio is:
= 40%
$80,000
Each $1 00 increase in sales results in a
= 40%
$200,000
Each $1.00 increase in sales results in a
total contribution margin increase of 40.
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Contribution Margin Ratio
O i t f it th t ib ti i ti i Or, in terms of units, the contribution margin ratio is:
Unit CM
CM Ratio =
For Racing Bicycle Company the ratio is:
Unit selling price
CM Ratio =
For Racing Bicycle Company the ratio is:
$200 $200
$500
= 40%
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Contribution Margin Ratio
400 Bi kes 500 Bi kes
Sal es 200,000 $ 250,000 $
Less: vari abl e expenses 120,000 150,000
Contri buti on margi n 80,000 100,000
L fi d 80 000 80 000 Less: fi xed expenses 80,000 80,000
Net operati ng i ncome - $ 20,000 $
A $50,000 increase in sales revenue A $50,000 increase in sales revenue
results in a $20 000 increase in CM results in a $20 000 increase in CM results in a $20,000 increase in CM. results in a $20,000 increase in CM.
($50,000 ($50,000 40% = $20,000) 40% = $20,000)
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Break-Even Analysis
Here is the information from Racing Bicycle Company:
Total Per Uni t Percent
Sal es (500 bi kes) 250,000 $ 500 $ 100%
Less: vari abl e expenses 150 000 300 60% Less: vari abl e expenses 150,000 300 60%
Contri buti on margi n 100,000 $ 200 $ 40%
Less: fi xed expenses 80,000
Net operati ng i ncome 20,000 $
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Contribution Margin Method
The contribution margin method has two The contribution margin method has two
key equations.
Fi d B k i Fixed expenses
CM per unit
=
Break-even point
in units sold
Fixed expenses
CM ratio
=
Break-even point in
total sales dollars
CM ratio
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Contribution Margin Method
Lets use the contribution margin method Lets use the contribution margin method
to calculate the break-even point in total
sales dollars at Racing.
Fi d
Break even point in
Fixed expenses
CM ratio
=
Break-even point in
total sales dollars
$80,000 $80,000
40% 40%
= $200,000 break = $200,000 break--even sales even sales
40% 40%
$ 00,000 b ea $ 00,000 b ea e e saes e e saes
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Target Profit Analysis
Suppose Racing Bicycle Company wants Suppose Racing Bicycle Company wants
to know how many bikes must be sold y
to earn a profit of $100,000.
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The Contribution Margin Approach
The contribution margin method can be The contribution margin method can be
used to determine that 900 bikes must be
f f $100 000 sold to earn the target profit of $100,000.
Fi d + T t fit U it l t tt i Fixed expenses + Target profit
CM per unit
=
Unit sales to attain
the target profit
$80,000 + $100,000
$200/bik
= 900 bikes
$200/bike
900 bikes
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The Margin of Safety
Th i f f t i th f The margin of safety is the excess of
budgeted (or actual) sales over the
break-even volume of sales.
M i f f t T t l l B k l Margin of safety = Total sales - Break-even sales
Lets look at Racing Bicycle Company and
determine the margin of safety. g y
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The Margin of Safety
If we assume that Racing Bicycle Company has actual g y p y
sales of $250,000, given that we have already
determined the break-even sales to be $200,000, , ,
the margin of safety is $50,000 as shown.
Break-even
sal es
400 uni ts
Actual sal es
500 uni ts 400 uni ts 500 uni ts
Sal es 200,000 $ 250,000 $
Less: vari abl e expenses 120,000 150,000
Contri buti on margi n 80 000 100 000 Contri buti on margi n 80,000 100,000
Less: fi xed expenses 80,000 80,000
Net operati ng i ncome - $ 20,000 $
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The Margin of Safety
The margin of safety can be expressedas The margin of safety can be expressed as
20% of sales.
($50 000$250 000) ($50,000 $250,000)
Break-even
sal es
400 uni ts
Actual sal es
500 uni ts 400 uni ts 500 uni ts
Sal es 200,000 $ 250,000 $
Less: vari abl e expenses 120,000 150,000
Contri buti on margi n 80 000 100 000 Contri buti on margi n 80,000 100,000
Less: fi xed expenses 80,000 80,000
Net operati ng i ncome - $ 20,000 $
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The Margin of Safety
The margin of safety can be expressedin The margin of safety can be expressed in
terms of the number of units sold. The
margin of safety at Racing is $50 000 and margin of safety at Racing is $50,000, and
each bike sells for $500.
Margin of
100 bik
$50,000 Margin of
Safety in units
= = 100 bikes
$50,000
$500
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Operating Leverage
A measure of howsensitive net operating A measure of how sensitive net operating
income is to percentage changes in sales.
Contribution margin Degree of Contribution margin
Net operating income
Degree of
operating leverage
=
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Operating Leverage
At Racing the degree of operating leverage is 5
Actual sales
At Racing, the degree of operating leverage is 5.
500 Bikes
Sales 250,000 $
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 80,000
Net income 20,000 $
$100,000
= 5
,
$20,000
= 5
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Operating Leverage
With an operating leverage of 5 if Racing With an operating leverage of 5 if Racing With an operating leverage of 5, if Racing With an operating leverage of 5, if Racing
increases its sales by 10%, net operating increases its sales by 10%, net operating
income o ld increase b 50% income o ld increase b 50% income would increase by 50%. income would increase by 50%.
P t i i l
10%
Percent increase in sales
10%
Degree of operating leverage
5
Percent increase in profits
50%
Heres the verification!
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Operating Leverage
Actual sal es Increased Actual sal es
(500)
Increased
sal es (550)
Sal es 250,000 $ 275,000 $
Less vari abl e expenses 150,000 165,000
Contri buti on margi n 100,000 110,000
Less fi xed expenses 80,000 80,000
Net operati ng i ncome 20,000 $ 30,000 $
10% increase in sales from
$250,000 to $275,000 . . .
. . . results in a 50%increase in . . . results in a 50% increase in
income from $20,000 to $30,000.
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The Concept of Sales Mix
S l i i th l ti ti i hi h Sales mix is the relative proportion in which a
companys products are sold.
Different products have different selling prices,
cost structures, and contribution margins.
Lets assume Racing Bicycle Company sells g y p y
bikes and carts and that the sales mix between
the two products remains the same. p
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Multi-product break-even analysis
Racing Bicycle Co. provides the following information:
$265 000 $265,000
$550,000
= 48.2% (rounded)
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Multi-product break-even analysis
Fixed expenses
CM Ratio
Break-even
sales
$170 000
=
$170,000
48.2%
= $352 697
=
= $352,697
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Key Assumptions of CVP Analysis
Selling price is constant. Selling price is constant.
Costs are linear.
In multiproduct companies, the sales mix is
constant. constant.
In manufacturing companies, inventories do
t h ( it d d it ld) not change (units produced = units sold).
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