financial and cost volume profit models © 2012 pearson prentice hall. all rights reserved

FINANCIAL AND COST VOLUME PROFIT MODELS

© 2012 Pearson Prentice Hall. All rights reserved.


Class Announcements

No office hours today (Monday September 16th) See SCC for information on information sessions Next class: Cloudwalkers (available on-line) Assignment #1 due September 19th (journal entries are

for bonus marks!) Business Society Golf Tournament (Daily Schwartz on

Facebook) Date: Saturday Sept 21st (Colin MacInnis, at x2010qbn) Time: tee off times begin at 12:00pm Location: Antigonish Golf & Country Club (87 Cloverville road) Team size: 4 Fee: $50/team member

Invest-X Initial Meeting on Monday September 16th in SCHW 152


Class Objectives

1. Understanding the impact of financial modeling

2. Cost Volume Profit analysis as a simplistic but powerful form of financial modeling

3. Incorporating target income, taxes, margin of safety, operating leverage, multiple products/services, etc.


Financial Models

Financial Models (definition): Accurate, reliable simulations of relations

among relevant costs, benefits, value and risk that are useful for supporting business decisions.

Financial Models (objectives): To improve the quality of decisions To allow flexible and responsive analyses To simulate the reality of the relevant

factors and relationships


Financial Models: CVP Analysis

Cost-Volume-Profit (CVP) analysis is the study of the effect of output volume on revenue, expense and net income

Managers use CVP analysis to try and obtain the most profitable combination of variable and fixed costs

Computers allow the manager to use a CVP modeling program to extensively and at minimal cost analyze relationships and to remove simplistic assumptions


CVP: Key Assumptions

Selling price (per unit), variable costs (per unit) and fixed costs (total) are constant;

Revenue and costs are linear; Costs are separable into variable and

fixed costs; In multi-product companies, the sales mix

is constant; and In manufacturing companies, inventories

do not change (units produced = units sold).


CVP: Break-Even

Breakeven analysis is the primary analysis of CVP analysis 1) Contribution-Margin Technique

B/E in units = Fixed expense Contribution margin per unit B/E in sales = Fixed expenses Contribution margin ratio

2) Equation Technique

sales-variable expenses-fixed expenses = 0 3) Graphical Technique

Selling Price

SalesQuantit

y*( )-( )*

UnitVariabl

e Costs

SalesQuantit

y-

Fixed

Costs

=

Operating

Income


CVP: Graphically


CVP: Weighted Contribution Margin

When the sales mix changes, the break-even point and the expected net income at various sales levels are altered

B/E in units = Fixed expense Weighted CM per unit

Sales mix is the relative proportions or combinations of quantities of products that comprise total sales

Weighted average contribution margin is: WCM = (Sales Mix) x (CM per Product Type)


CVP: Profit Planning (Targeted Income)

The breakeven point formula can be modified to become a profit planning tool. Profit is now reinstated to the BE formula,

changing it to a simple sales volume equation. Quantity of Units = (Fixed Costs + Operating

Income) Required to Be Sold Contribution Margin

per Unit


Breakeven Point: Profit Planning (p.24)


CVP: Income Taxes

After-tax profit can be calculated by: Net Income = Operating Income * (1-Tax

Rate) Net income can be converted to

operating income for use in CVP equation Operating Income = I I Net Income I (1-Tax Rate)


CVP: Margin of Safety

One indicator of risk, the margin of safety (MOS), measures the distance between budgeted sales and breakeven sales: MOS = Budgeted Sales – BE Sales

The MOS ratio removes the firm’s size from the output, and expresses itself in the form of a percentage: MOS Ratio = MOS ÷ Budgeted Sales


CVP: Operating Leverage

Operating leverage is a measure, at a particular level of sales, of the % impact on net income of a given % change in sales

In highly leveraged companies (high fixed costs and low variable costs) a small change in sales volume results in a large change in net income (i.e. riskier)

Operating leverage (OL) is the effect that fixed costs have on changes in operating income as changes occur in units sold, expressed as changes in contribution margin.

OL = Contribution Margin Operating Income


Class Objectives - Revisited

1. Understanding the impact of financial modeling

2. Cost Volume Profit analysis as a simplistic but powerful form of financial modeling

3. Incorporating target income, taxes, margin of safety, operating leverage, multiple products/services, etc.

financial and cost volume profit models © 2012 pearson prentice hall. all rights reserved

Documents