Cost-Volume-Profit Analysis

What is CVP analysis?

CVP analysis is a method for analyzing how operating decisions and marketing decisions affect profit

What does CVP rely on?

CVP relies on an understanding of the relationship between variable costs, fixed costs, unit selling price, and output level (volume)

When CVP analysis can be used?

Setting prices for products and services, Determining whether to introduce a new product or service, Replacing a piece of equipment, Determining breakeven point, Making “Make-or-buy” (i.e., sourcing) decisions, Determining the best product mix, Performing strategic “what-if” (sensitivity) analysis

What is the model of CVP?

Operating profit = Sales - Total costs

What is unit contribution margin and how do we calculate it?

the increase in operating profit for a unit increase in sales = (p – v); Unit contribution margin (cm) = Unit sales price (p) – Unit variable cost (v)

How do we calculate total contribution margin (CM)?

Unit contribution margin (cm) x Units sold (Q)

How do we calculate contribution margin ratio?

Unit contribution margin (cm)/unit sales price (p)

What are the features of The contribution income statement?

A useful way to show information developed in CVP analysis, Classifies costs based on cost behavior (fixed versus variable) rather than cost type (product versus period), Provides an easy and accurate prediction of the effect of a change in sales on profits

What is the strategic role of CVP analysis?

CVP analysis can help a firm choose its competitive position and execute its strategy by providing an understanding of how changes in sales volume affect costs and profits, CVP analysis is also important in life-cycle costing and target costing

Why CVP is important for companies?

This process is most important for cost leadership firms during the manufacturing stage, Differentiated firms use CVP analysis to assess profitability and desirability of new products and features

How CVP can assist in life-cycle costing?

CVP analysis can assist in life-cycle costing by helping to determine whether a product is likely to achieve its Strategic Role of CVP Analysis determine whether a product is likely to achieve its desired profitability, the most cost-effective manufacturing process, the best marketing and distribution channels, the best compensation plan, whether to offer discounts, etc.

How CVP can assist in target costing?

CVP analysis can assist in target costing by showing the effect on profit of alternative product designs that have different target costs

What is the breakeven point?

is the point at which revenues equal total costs and profit is zero

How the breakeven point can be determined?

In two ways 1. Equation Method: Based on Units Sold (Q units); Based on Sales Dollars (Y$)' 2. Contribution Margin Method: Based on units sold (Q units); Based on sales dollars (Y$)

How to find breakeven in dollars, when price and unit variable cost are not known?

the management accountant uses the contribution margin ratio = (p-v)/p

What ilustrates the CVP graph?

The CVP graph illustrates how the levels of revenues and total costs change as output (sales volume) changes

What ilustrates the PV graph?

profit-volume (PV) graph illustrates how the A profit volume (PV) graph illustrates how the level of operating profit changes as output (sales volume) changes

What PV graph allows for?

This graph allows a person to clearly see how total contribution margin, and therefore profit, changes as the output level (i.e., volume) changes

What management decisions about costs and prices must include and why?

income taxes because taxes affect the amount of net profit at a given level of sales

When we can use activity based costing and why?

If the assumption is made that total batch-level costs are fixed relative to the number of batches, both are fixed relative to the number of batches, both approaches will produce the same result; if the activity cost pool is a mixed cost, the ABC approach is more accurate because the volume-based approach treats all activity costs that do not vary with output volume, such as machine setup, materials handling, inspection, and engineering, as fixed

What is the sensitivity analysis?

Sensitivity analysis is the name for a variety of methods that examine how an amount (e.g., B/E point) changes if factors involved in predicting that amount change (e.g., sales volume or unit variable cost)?

Which methods of sensitivity analysis are commonly employed?

1 What-if analysis (using the contribution margin and contribution margin ratio) 2 The margin of safety (or, margin of safety ratio) 3 Operating leverage

What is what-if analysis?

it is the calculation of an amount given different levels of a factor that influences that amount

Read and understand this example

if contribution margin (cm) is $40 per unit and the cm ratio is 0.53333, each unit change in sales volume affects profit by $40 and each dollar change in sales affects profits by $0.53333

What is margin of safety?

is the dollar amount of sales above the B/E point

What is the margin of safety ratio?

It is the margin of safety divided by planned sales. This ratio is a useful measure for assessing risk

What CVP analysis is particulary important in?

in planning the use of new manufacturing technologies that have the potential to change the relationship between fixed and variable cos

What can be measured by operating leverage?

The potential effect of the risk that sales will fall short of planned levels, as influenced by the relative proportion of fixed to variable manufacturing costs

What is the degree of operating levarage?

contribution margin/before tax profit

What indicates the higher value for operating leverage?

a higher risk in the sense that a given change in sales will have a relatively greater impact on profits

When the organization can develop a separate CVP model for each product?

If all fixed costs are traceable to individual products

What assumption can the multi-product firm make?

assumption regarding a standard sales mix in which its products are sold regarding a standard sales mix in which its products are sold

How sales mix can be determined?

on the basis of sales dollars or unit sales

What are the assumptions of CVP analysis?

For conventional CVP analysis, volume of sales (units) is the only important cost driver only important cost driver; Costs, both variable and fixed, are linear within the relevant range of output; The revenue function is linear within the relevant range

Why is it impractical to apply CVP analysis separately for each product?

The existence of joint/common complicates short-run profit planning through CVP analysis; If the firm knows that its sales mix remains constant as total volume changes, then it can use for profit-planning purposes a weighted-average cm per unit or a weighted-average cm ratio