Lecture 23

Lecture Overview

• Cost-Volume-Profit Relationships• The Basics of Cost-Volume-Profit (CVP) Analysis• The Contribution Approach• Contribution Margin Ratio• MCQs Test• Changes in Fixed Costs and Sales Volume• Break-Even Analysis

– Equation Method

Contribution Margin Method

The contribution margin method is a variation of the equation method.

Fixed expenses Unit contribution margin =Break-even point

in units sold

Fixed expenses CM ratio

=Break-even point intotal sales dollars

MCQs Test The average selling price of a cup of coffee is

$1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average.

What is the break-even sales in units?a. 872 cupsb. 3,611 cupsc. 1,200 cupsd. 1,150 cups

MCQs Test Coffee Klatch is an espresso stand in a

downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the break-even sales in units?a. 872 cupsb. 3,611 cupsc. 1,200 cupsd. 1,150 cups

Breakeven q =F

cm

=$1,300

$1.49 - $0.36

=$1,300$1.13

= 1,150

MCQs Test Coffee Klatch is an espresso stand in a

downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the break-even sales in dollars?a. $1,300b. $1,715c. $1,788d. $3,129

MCQs Test Coffee Klatch is an espresso stand in a

downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the break-even sales in dollars?a. $1,300b. $1,715c. $1,788d. $3,129

Breakeven Sales =F

CM Ratio

=$1,3000.758

= $1,715

CVP Relationships in Graphic FormViewing CVP relationships in a graph gives managers a

perspective that can be obtained in no other way. Consider the following information for Wind Co.:

Income 300 units

Income 400 units

Income 500 units

Sales 150,000$ 200,000$ 250,000$ Less: variable expenses 90,000 120,000 150,000 Contribution margin 60,000$ 80,000$ 100,000$ Less: fixed expenses 80,000 80,000 80,000 Net income (loss) (20,000)$ -$ 20,000$

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

- 100 200 300 400 500 600 700 800

CVP Graph

Fixed expenses

Units

Dol

lars

Total Expenses

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

- 100 200 300 400 500 600 700 800

Units

Dol

larsCVP Graph

Total Sales

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

- 100 200 300 400 500 600 700 800

Units

Dol

larsCVP Graph

Break-even point

Profit Area

Loss Area

Target Profit Analysis

Suppose Wind Co. wants to know how many bikes must be sold to earn a profit of

$100,000.

We can use our CVP formula to determine the sales volume needed to achieve a target net

profit figure.

The CVP EquationSales = Variable expenses + Fixed expenses + Profits

$500Q = $300Q + $80,000 + $100,000

$200Q = $180,000

Q = 900 bikes

The Contribution Margin Approach

We can determine the number of bikes that must be sold to earn a profit of $100,000 using the

contribution margin approach.

Fixed expenses + Target profit Unit contribution margin=Units sold to attain

the target profit

$80,000 + $100,000 $200 = 900 bikes

MCQs Test Coffee Klatch is an espresso stand in a

downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. How many cups of coffee would have to be sold to attain target profits of $2,500 per month?a. 3,363 cupsb. 2,212 cupsc. 1,150 cupsd. 4,200 cups

MCQs Test Coffee Klatch is an espresso stand in a

downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. How many cups of coffee would have to be sold to attain target profits of $2,500 per month?a. 3,363 cupsb. 2,212 cupsc. 1,150 cupsd. 4,200 cups

q to attain target =F + Target profit

cm

=$1,300 + $2,500

$1.49 - $0.36

=$3,800$1.13

= 3,363

The Margin of Safety

Excess of budgeted (or actual) sales over the break-even volume of sales. The amount by which sales can drop before losses begin to

be incurred.

Margin of safety = Total sales - Break-even sales

Let’s calculate the margin of safety for Wind.

The Margin of Safety

Wind has a break-even point of $200,000. If actual sales are $250,000, the margin of safety

is $50,000 or 100 bikes.Break-even

sales 400 units

Actual sales 500 units

Sales 200,000$ 250,000$ Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net income -$ 20,000$

Break-even sales

400 unitsActual sales

500 unitsSales 200,000$ 250,000$ Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net income -$ 20,000$

The Margin of Safety

The margin of safety can be expressed as 20 percent of sales.

($50,000 ÷ $250,000)

MCQs Test Coffee Klatch is an espresso stand in a

downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the margin of safety?a. 3,250 cupsb. 950 cupsc. 1,150 cupsd. 2,100 cups

MCQs Test Coffee Klatch is an espresso stand in a

downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the margin of safety?a. 3,250 cupsb. 950 cupsc. 1,150 cupsd. 2,100 cups

Margin of safety = Total sales -Breakeven sales = 2,100 cups - 1,150 cups = 950 cups orMargin of safety

percentage = 950 cups

2,100 cups= 45%

Cost Volume Profit AnalysisTwo friends wished to start business of delivering pizza to the residents of Islamabad by through phone calls for home delivery within 30 minutes margin. They allocate fixed cost of Rs 40000 and sales price RS. 100. Its variable costs Rs. 50 to make and deliver each pizza. Requirements• Using contribution margin approach, compute breakeven

point per pizzas.• What is the contribution margin ratio?• Compute the break-even sales revenue.• How many pizzas must they sold to earn a target net profit

of RS. 65000?

Company Oliver located in Karachi manufactures computer casing. The firm`s fixed costs are Rs. 4000000 per month while prices are Rs. 3000 and Variable Cost Rs. 2000 each. Company sold 5000 components during the previous year.

Requirements• Compute the break-even point in units.• What will the new break-even point be if fixed costs increase

by 10 percent?• What was the company`s net income for the prior year?• The sales manager believes that a reduction in the sales price

to Rs 2500 will result in orders for 1200 more components each year. What will be break-even point be if price is changed?

• Should the price change discuss in requirement (4) be made?

Lecture Overview• Contribution Margin Method• MCQs Test• CVP Relationships in Graphic Form• CVP Graph• Target Profit Analysis• The CVP Equation• The Contribution Margin Approach• The Margin of Safety• Practice questions

End of Lecture 23