Cost-Volume-Profit

Analysis

Week 02 Topic 04

ACCT112: Management Accounting

Themin Suwardy, SMU 2005

Seminar Outline
1. CVP Analysis
2. Sensitivity Analysis & CVP
3. Margin of Safety (MOS & MOS%)
4. Degree of Operating Leverage (DOL)
5. Relationship between MOS% and DOL
6. Multiple Products CVP (and Break-Even)
Slide 2

1.1 Purpose of learning CVP analysis

What produces Profit?

Profit

More specifically:
How many units must
we sell to earn $X in
profit?

Volume?

Sales?

Slide 3

Costs?

1.2 The Concepts behind the CVP formula

Profit (P) = CM - FC
P = Q x (SP VC) - FC
Q = (FC + P) / (SP VC)

Profit

FC = Fixed Costs (Total)

Q = Quantity or # of units Sold
CM (Total) = Q x (SP VC)

Volume?

CM / unit = Contribution Margin ($) per unit

CM / unit = SP - VC

Sales?

Costs?

SP = Sales Price per unit

VC = Variable Costs per unit

Slide 4

1.3 The Break-Even Formula

If the CVP formula is:

Q = (FC + P) / (SP VC)

The Break-Even formula where

Profit = 0, will be:
Q = FC / (SP VC)

Slide 5

Quick Check (1)

Month

Qty

Jan-13

Costs

Month

Qty

Costs

747

$67,045

Jul-13

475

$49,365

Feb-13

343

$40,785 Aug-13

781

$69,255

Mar-13

965

$79,425

Sep-13

557

$54,695

Apr-13

329

$39,875

Oct-13

953

$80,435

May-13

637

$59,895

Nov-13

327

$46,887

Jun-13

519

$52,225

Dec-13

851

$73,805

The sales price per unit has remained stable at $108 throughout the year.
(a) Compute the contribution margin per unit.
(b) Compute the monthly break-even point in number of units.
VC
VC ==
FC
FC (monthly)
(monthly) ==
BE
BE Qty
Qty ==
Slide 6

A Good Checking Habit

How do you know your
answer is NOT wrong?

Dont just check your workings!

i.e. Whenever possible work

backward from your answer!
Slide 7

1.4 Contribution Margin Ratio

Sometimes it is not
convenient or
necessary to compute
break-even in units
e.g.

Revenue
Variable Costs
Contribution Margin
Fixed Costs
Operating Income

$8,000
$4,800
$3,200
$2,000
$1,200

Contribution Margin Ratio (CMR) = CM $ / Sales $

CMR = $3,200 / $8,000 = 40%
BE Sales$ = FC / CMR
BE Sales$ = $2,000 / 0.4 = $5,000
BE % = BE / Sales = $5,000 / $8,000 = 62.5%
Slide 8

2.1 Sensitivity Analysis & CVP

Breakeven Qty = FC / (SP-VC) or FC/CM
What is the break-even point
IF FC changed by x%?

IF SP changed by y%?
IF VC changed by z%?

Slide 9

A Practice Question

Boey Tah Han Ltd makes and sells only one product.
The products variable cost per unit is coincidentally
exactly 0.5% of the companys monthly total fixed costs. The
company currently sells its products at a price that is
equivalent to a 20% mark-up over variable cost.
Required Answers:
(a) The companys monthly Break Even quantity is
________________units
(b) A 20% decline in variable cost per unit (and nothing else
changes), translates to a _____________%
_______________ (decrease or increase) in the companys
monthly break-even quantity.

Slide 10

Answers to Practice Question - Part (a)

Slide 11

Answers to Practice Question - Part (b) - Algebraic

Slide 12

Answers to Practice Question - Part (b) - Numeric

Slide 13

The concepts behind CVP

(Cost Behaviour) also enable us
to compute two useful numbers.

Slide 14

3.1 Margin of Safety

i.e. By how much can the current

(actual or budgeted) sales fall
before the company starts to lose
money (or starts to make a loss)?

Revenue
Variable Costs
Contribution Margin
Fixed Costs
Operating Income
Slide 15

$8,000
$4,800
$3,200
$2,000
$1,200

3.2 Margin of Safety - The formula

Margin of Safety ($) = Sales Breakeven Sales
MOS = $8,000 - $5,000 = $3,000
Previously computed

Margin of Safety % = MOS / Sales

MOS % = $3,000 / $8,000 = 37.5 %
What was the BE % previously computed?
Slide 16

62.5%

A useful relationship to remember

MOS % = 1 - BE %
BE % = 1 - MOS %

Slide 17

4.1 Degree of Operating Leverage (DOL) & Formula

i.e. By how much will the

companys profit change if Sales
change by x % ?

DOL = Total CM / Operating Income

Change in Operating Income % = DOL x Change in Sales
%

Slide 18

4.2 Illustration of DOL - Base Case

Operating Leverage = Total CM / Operating Income

Sales
Variable Costs
Contribution
Fixed Costs
Operating Income

Qty
500

Per Unit
$500
$300
$200

Ops Lev = $100,000 / $20,000 = 5

Slide 19

Total
$250,000
$150,000
$100,000
$80,000
$20,000

Meaning ?

4.2 Illustration of DOL - If Sales Drop by 10%

90% of 500

Sales
Variable Costs
Contribution
Fixed Costs
Operating Income

Qty
450

Per Unit
$500
$300
$200

Total
$225,000
$135,000
$90,000
$80,000
$10,000

Operating Income drops from $20k to $10k = 50%

Change in Income = DOL x Change in Sales !
Slide 20

4.2 Illustration of DOL - If Sales Increase by 20%

120% of
500

Sales
Variable Costs
Contribution
Fixed Costs
Operating Income

Qty
600

Per Unit
$500
$300
$200

Total
$300,000
$180,000
$120,000
$80,000
$40,000

Operating Income increases from $20k to $40k = 100%

Change in Income = DOL x Change in Sales !
Slide 21

5.1 Relationship between MOS% and DOL

What is the MOS% from the Base Case?

BEQ = FC / (SP VC) = $80,000 / ($500 - $300)

BEQ = 400 units
Alternative approach to
computing this?

MOS % = (500 400) / 500 = 20%

DOL = 1 / MOS%

MOS% = 1 / DOL

Slide 22

Practice Question

Data:
Sales Price per unit
= $50
Variable Costs per unit
= $30
Fixed Cost per month
= $52,000
Budgeted Sales for September = 3,000
units
Compute the % change in profit for
September if Sales were to increase by
20% (as compared to budget).
You have a few minutes to work out your answer

Slide 23

Slide 24

Answers to Practice Question

Slide 25

6.1 Multiple Products CVP

Expected sales
Selling price per unit
Total Revenue
Total Variable costs
Total CM
Total Fixed costs
Operating income

Product A Product B
60 units
40 units
$200
$100
$12,000
$4,000
$7,200
$2,800
$4,800
$1,200

DONT apportion total fixed

costs to individual products
and solve at Product level.
Slide 26

F
Total
100 units
$16,000
$10,000
$6,000
$4,500
$1,500

6.2 Multiple Products CVP: Method (1) - using CM

(1)

Bundle the products using the given sales mix (ratio of units sales):
60 units of A: 40 units of B

(2) CM of bundle = $6,000 (given)

(3) Let Q be the number of bundles to break even,
Total CM
= FC
Q x $6,000
= $4,500 (given)
Q
= 0.75 bundles
(4)

Product A
Product B

= 0.75 bundles x 60 units per bundle

or 45 x $200 = $9,000
= 0.75 bundles x 40 units per bundle
or 30 x $100 = $3,000

Slide 27

= 45 units;
= 30 units;

6.3 Multiple Products CVP: Method (2) - using CMR

(1)

Determine sales mix of company (ratio of $ sales):

$12,000 sales of A : $4,000 sales of B
0.75 A
:
0.25 B
(or 75% A: 25% B)

(2)

CM ratio of company = $6,000 / $16,000 = 0.375

(3)

(4)

Let $Z be the $ sales to break even,

Total CM
= FC
$Z x 0.375
= $4,500
$Z
= $12,000 sales for whole company
Product A Sales to breakeven = 0.75 x $12,000 = $9,000
Product B Sales to breakeven = 0.25 x $12,000 = $3,000

Slide 28

6.3 Multiple Products CVP: Method (3) - using DOL

Objective is to find BE%.
BE% = 1- MOS%
MOS% = 1 / DOL
(1)

DOL = CM / Operating Income = $6,000 / $1,500 = 4

(2)

MoS% = 1 / DOL = 1 / 4 = 0.25 (or 25%)

(3)

BE%

(4)

BE Sales = BE% x given sales

= 1 - MoS% = 0.75 (or 75%)

Revenue (given)
BE Sales ($)

Product A

Product B

$12,000
0.75 x $12,000
= $9,000

$4,000
0.75 x $4,000
= $3,000

Slide 29

A Final Practice Question

Product A Product B
Sales Quantity (units)
300
500
Sales $
$12,000
$25,000
Variable Costs
$15,000
$20,000
CM
($3,000)
$5,000
Total Fixed Costs = $3,600
Sales Price (units)

Product C
100
$13,000
$3,000
$10,000

Assume you HAVE TO sell Product A

Calculate the BE (Qty or $) for each product.

Slide 30

Answer to Practice Question (1) - using CM

Sales mix of 1 bundle (units):

300 A : 500 B : 100 C

Using the Sales Price you can convert answers to BE $

Slide 31

Answer to Practice Question (2) - using CMR

Sales $
Sales Mix ($)

Product A
$12,000
0.24

Product B
$25,000
0.50

Product A

Product C
$13,000
0.26

Product B

Total
$50,000

Product C

BE sales (of product)

Using the Sales Price you can convert answers to BE Qty

Slide 32

Answer to Practice Question (3) - using DOL

Sales $
Variable Costs
CM
Fixed Costs
Profit

Product A
$12,000
$15,000
($3,000)

Product B
$25,000
$20,000
$5,000

Product C
$13,000
$3,000
$10,000

Product A

Product B

Product C

Total
$50,000
$38,000
$12,000
$3,600
$8,400

BE $ (of product)

Using the Sales Price you can convert answers to BE Qty

Slide 33

Q&A

Slide 34

Reinforcing Formula used

CM
CM Ratio
Ratio ??
MOS
MOS
MOS
MOS %
%
BE
BE %
%

DOL
DOL

CMR = CM $ / Sales $

MOS = Sales$ - BE$

or Sales Q BE Q

MOS % = MOS$ / Sales $ or MOS Q / Sales Q

BE% = BE / Sales

(Qty or $)

BE% = 1 - MOS%
DOL = CM $ / Operating Income $
DOL = 1 / MOS %

Slide 35

Example of Exam/Test Question for Topic 04

2014-15-T1 - Final Exam - Case B

Slide 36