mba 6011 cvp highlights for oct 23 2013
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MBA 6011module 15
COST-VOLUME-PROFIT
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CVP Assumptions
1. All costs are classified as fixed or variable.
2. The total cost function is linear within therelevant range.
3. The total revenue function is linear within therelevant range.
4. The analysis is for a single product, or the salesmix of multiple products is constant.
5. There is only one activity cost driver: unit ordollar sales volume.
Warning: accuracy decreases as the scope
of operations being analyzed increases.
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Using the Profit Formula
To use the profit formula
Separate all the companys costs into variable and
fixed components
Nature of costs
The cost of the primary raw materials convertedinto finished goods
Wages earned by production employees
converting raw materials into finished goods
Variable
Costs
Direct materials
Direct labor
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All other variable costs associated with converting
raw materials into finished goods
All variable costs not directly associated withconverting raw materials into finished goods
All fixed costs associated with converting rawmaterials into finished goods
All fixed costs not directly associated with
converting raw materials into finished goods
Variable and Fixed Components
Fixed
Costs
Variable
Costs
Variable manufacturing overhead
Variable selling and administrative costs
Fixed manufacturing overhead
Fixed selling and administrative costs
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Contribution Income Statement
Example
Sales (6,950 x $1.50) $10,425.Less variable costs:
Direct materials (6,950 x $0.43) $2,988Direct labor (6,950 x $0.32) 2,224Manufacturing overhead (6,950 x $0.20) 1,390
Selling and administrative (6,950 x $0.15) 1,043 (7,645)Contribution margin 2,780.
Less fixed costs:Manufacturing 1,200Selling and administrative 580 (1,780)
Net Operating Profit $1,000.
Rock-N-Roehl Cream Bars
Contribution Income Statement
For a Mon thly Volume of 6,950 Ice Cream Bars
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Analysis Using
Contribution Margin (Unit or Ratio)
Sensitivity analysis
How a model responds to changes in one or more
independent variables Unitcontribution margin
Indicates how sensitive an income model is to a
change in unit sales Contribution margin ratio
The portion of every sales dollar contributed toward
covering fixed costs and earning a profit
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Break-Even Point
Fixed costsSelling price per unit Variable costs per unit
=Fixed costs
Contribution margin per unit
=
Break-even unit sales volume
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Multiple Product
Break-Even Point
Applicable when unit information is not available or
when a company sells more than one product.
=Fixed costs
Contribution margin ratio
=Fixed costs + Desired profit
Contribution margin ratio
Dollar break-even point
Target dollar sales volume
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Operating Leverage
What is operating leverage?A measure of the extent that an organizations costs
are fixed
High degree of operating leverage Signals the existence of a high portion of fixed costs
Degree ofoperatingleverage
Contribution marginIncome before taxes
=
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Operating Leverage
Risk & Opportunity
The higher the degree of operating leverage
The greater the opportunity for profit with increases
in sales, AND
The greater the risk of large losses when sales
decrease
Sales Increase Sales Decrease
High operating leverageHigh opportunity
for profit increasesHigh risk of loss
Low operating leverage Low opportunity forprofit increases
Low risk of loss
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Measuring Expected
Change in ProfitTaco King and Mexi Land are competitors and reported the same salesrevenue and before-tax profit during May:
Taco King Mexi Land
Sales $40,000 $40,000.Variable costs (22,000) (8,000)
Contribution margin 18,000 32,000.Fixed costs (8,000) (22,000)Before-tax profit $10,000. $10,000.
If sales drop by 20% for both, which company suffers more?
Degree ofoperating leverage
Taco King Mexi Land
$18,000
$10,000= 1.8 $32,000
$10,000= 3.2
Decreasein profit
1.820% = 36%Decline in Profit
3.220% = 64%Decline in Profit
Mexi Lands higher operating leverage results in a larger profit decline.
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