CVP Analysis GNB 06 12e.ppt - csus.edu

1 CVP Analysis1 Uses of the Contribution FormatUses o t e Co t but ooatThtib tiit ttftidThtib tiit ttftidThe 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. Thih if l fThih if l fThis approach is useful for:This approach is useful CostCost--volumevolume--profit Analysis profit Analysis Segmented reporting of profit Segmented reporting of profit datadata44 Special decisions s ch as pricing and makeSpecial decisions s ch as pricing and decisions such as pricing and makeSpecial decisions such as pricing and make--oror--buy buy analysisanalysis2 The Contribution FormatUsed primarily forUsed primarily forexternal reportingexternal reportingUsed primarily byUsed primarily bymanagementmanagementexternal Contribution FormatTotalUnitTotalUnitSales Revenue100.

2 000$ 50$ Less: Variable costs60 00030 Less: Variable costs60,000 30 Contribution margin40,000$ 20$ Less: Fixed costs30,000 Net operating income10,000$ Tht ib tii fth iTht ib tii fth iThe contribution margin format emphasizes The contribution margin format emphasizes cost behavior. Contribution margin covers fixed cost behavior. Contribution margin covers fixed td idfitd idficosts and provides for and provides for Relationships in Graphic FormThe relationship among revenue, cost , profit and lb dhillbivolume can be expressed graphically by preparing a CVP graph.

3 Racing developed contribution margin income statements at 300, 400, and 500margin income statements at 300, 400, and 500 units sold. We will use this information to prepare the CVP 300 unitsIncome 400 unitsIncome 500 units$$$Sales150,000$ 200,000$ 250,000$Less: variable expenses90,000 120,000 150,000 Contribution margin60,000$ 80,000$ 100,000$gLess: fixed expenses80,000 80,000 80,000 Net operating income(20,000)$ -$ 20,000$ 6 CVP Graph4 0 000350 000400,000450,000 Total Sales250,000300,000350,000 Total ExpensesTotal Sales150,000200,000,Fixed ExpensesTotal Expenses50,000100,000--10020030040050060 0700800 UitUnits7 CVP Graph4 0 000350 000400,000450,000 BreakBreak--even pointeven point(400 units or $200,000 in sales)(400 units or $200,000 in sales)250,000300,000350,000150,000200,00 0,50,000100,000--10020030040050060070080 0 UitUnits8 Contribution Margin RatioThe contribution margin ratio is.

4 Total CMCM R tiFor Racing Bicycle Company the ratio is:Total CMTotal salesCM Ratio =For Racing Bicycle Company the ratio is:=40%$80,000 Each $1 00 increase in sales results in a= 40%$200,000 Each $ increase in sales results in a total contribution margin increase of 40 .9 Contribution Margin RatioOitfittht ib tiitiiOr, in terms of units, the contribution margin ratiois:Unit CMCM Ratio =For Racing Bicycle Company the ratio is:Unit selling priceCM Ratio = For Racing Bicycle Company the ratio is:$200$200$500= 40%10 Contribution Margin Ratio400 Bikes500 BikesSales200,000$ 250,000$ Less: variable expenses120,000 150,000 Contribution margin80,000 100,000 Lfid80 00080 000Le ss.

5 Fixed expenses80,000 80,000 Net operating income-$ 20,000$ A $50,000 increase in sales revenue A $50,000 increase in sales revenue results in a $20 000 increase in CMresults in a $20 000 increase in CMresults in a $20,000 increase in in a $20,000 increase in CM.($50,000 ($50,000 40% = $20,000)40% = $20,000)11 Break-Even AnalysisHere is the information from Racing Bicycle Company:TotalPer UnitPercentSales (500 bikes)250,000$ 500$ 100%Less: variable expenses150 00030060%Less: variable expenses150,000 300 60%Contribution margin100,000$ 200$ 40%Less.

6 Fixed expenses80,000 Net operating income20,000$ 12 Contribution Margin MethodThe contribution margin method has twoThe contribution margin method has two key expensesCM per unit =Break-even pointin units soldFixed expensesCM ratio=Break-even point intotal sales dollarsCM ratio13 Contribution Margin MethodLet s use the contribution margin methodLet s use the contribution margin method to calculate the break-even point in total sales dollars at point inFixed expensesCM ratio=Break-even point intotal sales dollars$80,000$80,00040%40%= $200,000 break= $200,000 break--even saleseven sales40%40%$ 00,000 b ea$ 00,000 b eaee saesee saes14 Target Profit AnalysisSuppose Racing Bicycle Company wantsSuppose Racing Bicycle Company wants to know how many bikes must be sold yto earn a profit of $100, Contribution Margin ApproachThe contribution margin method can beThe contribution margin method can be used to determine that 900 bikes must be ff $100 000sold to earn the target profit of $100, d+TtfitUit l t ttiFixed expenses + Target profitCM per unit=Unit sales to attainthe target profit$80,000 + $100.

7 000$200/bik=900 bikes$200/bike900 bikes16 The Margin of SafetyThiff t i thfThe margin of safety is the excess of budgeted (or actual) sales over the break-even volume of TtllBklMargin of safety = Total sales -Break-even salesLet s look at Racing Bicycle Company and determine the margin of Margin of SafetyIf we assume that Racing Bicycle Company has actual gypysales of $250,000, given that we have already determined the break-even sales to be $200,000, ,,the margin of safety is $50,000 as sales 400 unitsActual sales 500 units400 units500 unitsSales200,000$ 250,000$ Less.

8 Variable expenses120,000 150,000 Contribution margin80 000100 000 Contribution margin80,000 100,000 Less: fixed expenses80,000 80,000 Net operating income-$ 20,000$ 18 The Margin of SafetyThe margin of safety can be expressed asThe margin of safety can be expressed as 20%of sales.($50 000 $250 000)($50,000 $250,000)Break-even sales 400 unitsActual sales 500 units400 units500 unitsSales200,000$ 250,000$ Less: variable expenses120,000 150,000 Contribution margin80 000100 000 Contribution margin80,000 100,000 Less: fixed expenses80,000 80,000 Net operating income-$ 20,000$ 19 The Margin of SafetyThe margin of safety can be expressed inThe margin of safety can be expressed in terms of the number of units sold.

9 The margin of safety at Racing is $50 000 andmargin of safety at Racing is $50,000, and each bike sells for $ of100 bik$50,000 Margin ofSafety in units== 100 bikes$50,000$50020 Operating LeverageA measure of how sensitive net operatingA measure of how sensitive net operating income is to percentage changes in marginDegree ofContribution marginNet operating incomeDegree ofoperating leverage=21 Operating LeverageAt Racing the degree of operating leverage is 5 Actual sales At Racing, the degree of operating leverage is BikesSales250,000$ Less: variable expenses150,000 Contribution margin100,000 Less: fixed expenses80,000 Net income20,000$ $100,000 =5,$20,000= 522 Operating LeverageWith an operating leverage of 5 if RacingWith an operating leverage of 5 if RacingWith 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%.

10 Income would increase by 50%.Ptiil10%Percent increase in sales10%Degree of operating leverage 5 Percent increase in profits50%Here s the verification!23 Operating LeverageActua l sa le sIncreasedActua l sa l e s (500)Increased sa l e s (550)Sales250,000$ 275,000$ Less variable expenses150,000 165,000 Contribution margin100,000 110,000 Less fixed expenses80,000 80,000 Net operating income20,000$ 30,000$ 10% increase in sales from$250,000 to $275,000 .. results in a 50% increase in.. results in a 50% increase inincome from $20,000 to $30, Concept of Sales MixSli i thltiti i hih Sales mix is the relative proportion in which a company s products are sold.