COST-VOLUME-PROFIT RELATIONSHIPS

TM 5-1

COST-VOLUME-PROFIT RELATIONSHIPS

Cost-volume-profit (CVP) analysis is concerned with the effects on net

operating income of:

? Selling prices.

? Sales volume.

? Unit variable costs.

? Total fixed costs.

? The mix of products sold.

AGENDA

A. Review of contribution income statement.

B. Effects of changes in sales volume on net operating income.

C. CVP relationships in equation form

D. CVP and profit graphs.

E. Contribution margin (CM) ratio.

F. Target profit analysis.

G. Break-even analysis.

H. Margin of safety.

I. Operating leverage.

J. Multiproduct break-even analysis.

? The McGraw-Hill Companies, Inc., 2012. All rights reserved.

TM 5-2

THE CONTRIBUTION APPROACH

A contribution format income statement is very useful in CVP analysis

because it highlights cost behavior.

EXAMPLE: Last month¡¯s contribution income statement for Nord

Corporation, a manufacturer of exercise bicycles, follows:

Sales (500 bikes) ...........

Variable expenses ..........

Contribution margin .......

Fixed expenses ..............

Net operating income.....

Total

$250,000

150,000

100,000

80,000

$ 20,000

Per Unit

$500

300

$200

CONTRIBUTION MARGIN:

? The amount that sales (net of variable expenses) contributes toward

covering fixed expenses and then toward profits.

? The unit contribution margin remains constant so long as the selling

price and the unit variable cost do not change.

? The McGraw-Hill Companies, Inc., 2012. All rights reserved.

TM 5-3

VOLUME CHANGES AND NET OPERATING INCOME

Contribution income statements are given on this and the following page

for monthly sales of 1, 2, 400, and 401 bikes.

Sales (1 bike) ......................

Variable expenses ................

Contribution margin .............

Fixed expenses ....................

Net operating income (loss) ..

Sales (2 bikes) .....................

Variable expenses ................

Contribution margin .............

Fixed expenses ....................

Net operating income (loss) ..

$

Total

Per Unit

Total

Per Unit

500

300

200

80,000

$(79,800)

$ 1,000

600

400

80,000

$(79,600)

$500

300

$200

$500

300

$200

Note the following points:

1.

The contribution margin must first cover the fixed expenses. If it

doesn¡¯t, there is a loss.

2.

As additional units are sold, fixed expenses are whittled down until

they have all been covered.

? The McGraw-Hill Companies, Inc., 2012. All rights reserved.

TM 5-4

VOLUME CHANGES AND NET OPERATING INCOME (continued)

Sales (400 bikes) ...................

Variable expenses ..................

Contribution margin ...............

Fixed expenses ......................

Net operating income (loss)....

Sales (401 bikes) ...................

Variable expenses ..................

Contribution margin ...............

Fixed expenses ......................

Net operating income (loss)....

Total

Per Unit

Total

Per Unit

$200,000

120,000

80,000

80,000

$

0

$200,500

120,300

80,200

80,000

$

200

$500

300

$200

$500

300

$200

Note the following points:

1.

If the company sells exactly 400 bikes a month, it will just break even

(no profit or loss).

2.

The break-even point is:

? The point where total sales revenue equals total expenses (variable

and fixed).

? The point where total contribution margin equals total fixed

expenses.

3.

Each additional unit sold increases net operating income by the

amount of the unit contribution margin.

? The McGraw-Hill Companies, Inc., 2012. All rights reserved.

TM 5-5

CVP RELATIONSHIPS IN EQUATION FORM

Terry¡¯s Way shown in class:

Sales = Variable + Fixed + Net income

$500X = $300X + $80,000 + $0

$200X = $80,000

$200X = $80,000

$200

$200

X = 400 bicycles @break even

Sales = Variable + Fixed + Net income

$500X = $300X + $80,000 + $70,000

$200X = $150,000

$200X = $150,000

$200

$200

X = 750 bicycles @break even + $70,000 profit

? The McGraw-Hill Companies, Inc., 2012. All rights reserved.

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