Cost-volume-profit (CVP) analysis

focuses on how profits are affected by the following five factors: selling prices, sales volume, unit variable costs, total fixed costs, mix of products sold.

Break-even point

the level of sales at which the profit is zero

Cost-volume profit (CVP) graph

a graphical representation of the relationships between an organizations revenues, costs, and profits on the one hand and its sales volume on the other hand, graph is based on the following equation: Profit=Unit CM*Q-Fixed expenses

Incremental analysis

an analytical approach that focuses only on those costs and revenues that change as a result of a decision

Target profit analysis

estimating what sales volume is needed to achieve a specific target profit

The equation method

Profit=Unit CM*Q-Fixed expense

The formula method (short cut version of the equation method)

Unit sales to attain the target profit= (Target profit + Fixed Expenses)/Unit CM

Target Profit Analysis in terms of sales dollars

Dollar sales to attain a target profit= (Target profit + Fixed expenses)/ CM ratio

Break-even in unit sales

Unit sales to break even = Fixed expenses/Unit CM

Break-even in sales dollars

Dollar sales to break even= Fixed expenses/ CM ratio

The margin of safety

the excess of budgeted (actual) dollar sales over the break-even dollar sales

Margin of safety in dollars

total budgeted (or actual sales)-break-even sales

Margin of safety percentage

margin of safety in dollars/ total budgeted (or actual) sales in dollars

Operating leverage

a measure of how sensitive net operating income is to a given percentage change in dollar sales

The degree of operating leverage

a measure, at a given level of sales, of how a percentage change in sales will affect profits; DOL=contribution margin/net operating income

Sales mix

the relative proportion in which a company’s products are sold. Sales mix is computed by expressing the sales of each product as a percentage of total sales.

Assumptions of CVP analysis

selling price is constant, costs are linear and can be accurately divided into variable (constant per unit) and fixed (constant in total) elements, in multiproduct companies the sales mix is constant, in manufacturing companies inventories do not change (units produced=units sold)

Variable expense ratio

the ration of variable expenses to sales; total variable expense/sales OR variable expenses per unit/unit selling price

Contribution margin ratio (CM)

contribution margin/sales OR unit contribution margin/unit selling price; the relationship between profit and the CM ration can be expressed: Profit=CM ratio*sales-fixed expenses

CVP Equations

Profit= the contribution format income statement is expressed (sales-variable expenses)-fixed expenses; if a company sells only a single product, Sales = P*Q , Variable expenses: V*Q, Profit= (P*Q-V*Q)-fixed expenses