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Chapter 6
Chapter 6
Cost-Volume-ProfitRelationships
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Basics of Cost-Volume-Profit Analysis
Contribution Margin (CM) is the amountremaining from sales revenue after variable
expenses have been deducted.
Contribution Margin (CM) is the amountremaining from sales revenue after variable
expenses have been deducted.
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Basics of Cost-Volume-Profit Analysis
CM is used first to cover fixedexpenses. Any remaining CM
contributes to net operating income.
CM is used first to cover fixedexpenses. Any remaining CM
contributes to net operating income.
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Learning Objective
LO
LO
!o e"plain ho# changes inactivity affect contributionmargin an$ net operating
income%
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!he Contribution Approach &ales' variable e"penses' an$ contribution margin can
also be e"presse$ on a per unit basis% (f Racing sellsan a$$itional bicycle' )*++ a$$itional C, #ill be
generate$ to cover fi"e$ e"penses an$ profit%
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!he Contribution Approach
ach month' Racing must generate at least).+'+++ in total C, to brea/ even%
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!he Contribution Approach
(f Racing sells 0++ units0++ units in a month' it #illbe operating at the break-even point %
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!he Contribution Approach
(f Racing sells one more bi/e 10+ bi/es0+ bi/es2' netoperating income #ill increase by $200 %
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!he Contribution Approach
3e $o not nee$ to prepare an income statementto estimate profits at a particular sales volume%&imply multiply the number of units sol$ above
brea/-even by the contribution margin per unit%
(f Racing sells(f Racing sells
04+ bi/es' its04+ bi/es' its
net income #illnet income #illbe )6'+++%be )6'+++%
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Learning Objective
LO*LO*
!o prepare an$ interpret acost-volume-profit 1CVP2
graph%
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CVP Relationships in 5raphic orm
!he relationship among revenue' cost' profit an$ volume canbe e"presse$ graphically by preparing a CVP graph%
Racing $evelope$ contribution margin income statementsat 4++' 0++' an$ 7++ units sol$% 3e #ill use this
information to prepare the CVP graph%
Income
300 units
Income
00 units
Income
!00 units
"ales #!0$000% &00$000% &!0$000%
'ess variable expenses 0$000 #&0$000 #!0$000
Contribution margin *0$000% +0$000% #00$000%
'ess fixed expenses +0$000 +0$000 +0$000
,et operating income (&0$000)% -% &0$000%
Income
300 units
Income
00 units
Income
!00 units
"ales #!0$000% &00$000% &!0$000%
'ess variable expenses 0$000 #&0$000 #!0$000
Contribution margin *0$000% +0$000% #00$000%'ess fixed expenses +0$000 +0$000 +0$000
,et operating income (&0$000)% -% &0$000%
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CVP 5raph
nits
8 o
l l a r s
(n a CVP graph'(n a CVP graph' unit volumeunit volume isis
usually represente$ on theusually represente$ on the
hori/ontal () axishori/ontal () axis an$an$ dollarsdollars onon
thethe vertical (1) axisvertical (1) axis%%
(n a CVP graph'(n a CVP graph' unit volumeunit volume isis
usually represente$ on theusually represente$ on thehori/ontal () axishori/ontal () axis an$an$ dollarsdollars onon
thethe vertical (1) axisvertical (1) axis%%
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8 o
l l a r s
nits
CVP 5raph
2ixed xpenses
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CVP 5raph
8 o
l l a r s
nits
2ixed xpenses
4otal xpenses
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CVP 5raph
2ixed xpenses 8
o l l
a r s 4otal xpenses
4otal "ales
nits
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CVP 5raph
8 o
l l a r s
nits
5rea6-even point5rea6-even point
(00 units or %&00$000 in sales)(00 units or %&00$000 in sales)5rea6-even point5rea6-even point
(00 units or %&00$000 in sales)(00 units or %&00$000 in sales)
P r o f
i t A r e a
L o s s A r
e a
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Learning Objective
LO4LO4
!o use the contribution
margin ratio 1C, ratio2 tocompute changes in
contribution margin an$ netoperating income resulting
from changes in salesvolume%
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Contribution ,argin Ratio
!he contribution margin ratio is9
or Racing Bicycle Company the ratio is9
4otal CM4otal sales
CM 7atio 8
ach )%++ increase in sales results in atotal contribution margin increase of 0+:%
8 09%+0$000
%&00$000
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Contribution ,argin Ratio
Or' in terms of units' the contribution marginratio is9
or Racing Bicycle Company the ratio is9%&00%!00 8 09
nit CM
nit selling priceCM 7atio 8
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00 5i6es !00 5i6es
"ales &00$000% &!0$000%
'ess variable expenses #&0$000 #!0$000
Contribution margin +0$000 #00$000 'ess fixed expenses +0$000 +0$000
,et operating income -% &0$000%
00 5i6es !00 5i6es
"ales &00$000% &!0$000%
'ess variable expenses #&0$000 #!0$000
Contribution margin +0$000 #00$000 'ess fixed expenses +0$000 +0$000
,et operating income -% &0$000%
Contribution ,argin Ratio
A )7+'+++ increase in sales revenue A )7+'+++ increase in sales revenueresults in a )*+'+++ increase in C,%results in a )*+'+++ increase in C,%
1)7+'+++ ; 0+< = )*+'+++21)7+'+++ ; 0+< = )*+'+++2
A )7+'+++ increase in sales revenue A )7+'+++ increase in sales revenueresults in a )*+'+++ increase in C,%results in a )*+'+++ increase in C,%
1)7+'+++ ; 0+< = )*+'+++21)7+'+++ ; 0+< = )*+'+++2
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>uic/ Chec/
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average' *'++cups are sol$ each month% 3hat is the C, Ratiofor Coffee ?latch
a% %4@
b% +%7.c% +%*0*
$% 0%4@
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average' *'++cups are sol$ each month% 3hat is the C, Ratiofor Coffee ?latch
a% %4@
b% +%7.c% +%*0*
$% 0%4@
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Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average' *'++cups are sol$ each month% 3hat is the C, Ratiofor Coffee ?latch
a% %4@
b% +%7.c% +%*0*
$% 0%4@
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average' *'++cups are sol$ each month% 3hat is the C, Ratiofor Coffee ?latch
a% %4@
b% +%7.c% +%*0*
$% 0%4@
>uic/ Chec/
nit contribution marginnit selling price
CM 7atio 8
8(%#.-%0.3*)
%#.
8%#.#3%#.
8 0.:!+
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Learning Objective
LO0LO0
!o sho# the effects on
contribution margin ofchanges in variable costs'
fi"e$ costs' selling price' an$volume%
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Changes in i"e$ Costs an$ &ales Volume
3hat is the profit impact if Racing canincrease unit sales from 7++ to 70+ by
increasing the monthly a$vertising
bu$get by )+'+++
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Changes in i"e$ Costs an$ &ales Volume%+0$000 ; %#0$000 advertising 8 %0$000%+0$000 ; %#0$000 advertising 8 %0$000%+0$000 ; %#0$000 advertising 8 %0$000%+0$000 ; %#0$000 advertising 8 %0$000
"ales"ales increased increased by %&0$000$ but net operatingby %&0$000$ but net operating
incomeincome decreased decreased by %&$000by %&$000%%
"ales"ales increased increased by %&0$000$ but net operatingby %&0$000$ but net operating
incomeincome decreased decreased by %&$000by %&$000%%
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Changes in i"e$ Costs an$ &ales Volume
!he &hortcut &olution
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Change in Variable Costs an$ &ales Volume
3hat is the profit impact if Racing canuse higher uality ra# materials' thus'
increasing variable costs per unit by )+'
to generate an increase in unit salesfrom 7++ to 7.+
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Change in Variable Costs an$ &ales Volume
!+0 units!+0 units
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Change in i"e$ Cost' &ales Price an$ Volume
3hat is the profit impact if Racing 12 cutsits selling price )*+ per unit' 1*2 increases
its a$vertising bu$get by )7'+++ per
month' an$ 142 increases unit sales from7++ to 67+ units per month
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"ales"ales increaseincrease by %*&$000$ fixed costs increase byby %*&$000$ fixed costs increase by
%#!$000$ and net operating income%#!$000$ and net operating income increasesincreases by %&$000by %&$000%%
"ales"ales increaseincrease by %*&$000$ fixed costs increase byby %*&$000$ fixed costs increase by
%#!$000$ and net operating income%#!$000$ and net operating income increasesincreases by %&$000by %&$000%%
Change in i"e$ Cost' &ales Price an$ Volume
Change in Variable Cost i"e$ Cost an$
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Change in Variable Cost' i"e$ Cost an$&ales Volume
3hat is the profit impact if Racing 12 paysa )7 sales commission per bi/e sol$'
instea$ of paying salespersons flat salaries
that currently total )6'+++ per month' an$1*2 increases unit sales from 7++ to 77
bi/es
Change in Variable Cost i"e$ Cost an$
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Change in Variable Cost' i"e$ Cost an$&ales Volume
"ales"ales increaseincrease by %3:$!00$ variable costsby %3:$!00$ variable costs increaseincrease byby
%3#$#&!$ but fixed expenses%3#$#&!$ but fixed expenses decreasedecrease by %*$000by %*$000%%
"ales"ales increaseincrease by %3:$!00$ variable costsby %3:$!00$ variable costs increaseincrease byby
%3#$#&!$ but fixed expenses%3#$#&!$ but fixed expenses decreasedecrease by %*$000by %*$000%%
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Change in Regular &ales Price
(f Racing has an opportunity to sell 7+bi/es to a #holesaler #ithout $isturbing
sales to other customers or fi"e$
e"penses' #hat price #oul$ it uote to the#holesaler if it #ants to increase monthly
profits by )4'+++
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Change in Regular &ales Price
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Learning Objective
LO7LO7
!o compute the brea/evenpoint in unit sales an$ $ollar
sales%
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Brea/-ven Analysis
Brea/-even analysis can beBrea/-even analysis can be
approache$ in t#o #ays9approache$ in t#o #ays9
%% uation metho$uation metho$*%*% Contribution margin metho$Contribution margin metho$
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uation ,etho$
>rofits 8 ("ales ? @ariable expenses) ? 2ixed expenses
"ales 8 @ariable expenses ; 2ixed expenses ; >rofits
7
At the brea6-even pointAt the brea6-even point
profits eBual /eroprofits eBual /ero
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Brea/-ven Analysis
Dere is the information from Racing Bicycle Company9
4otal >er .nit >ercent"ales (!00 bi6es) &!0$000% !00% #009
'ess variable expenses #!0$000 300 *09
Contribution margin #00$000% &00% 09
'ess fixed expenses +0$000
,et operating income &0$000%
4otal >er .nit >ercent"ales (!00 bi6es) &!0$000% !00% #009
'ess variable expenses #!0$000 300 *09
Contribution margin #00$000% &00% 09
'ess fixed expenses +0$000
,et operating income &0$000%
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uation ,etho$
%!00 8 %300 ; %+0$000 ; %0
Dhere 8 ,umber of bi6es sold %!00 8 nit selling price %300 8 nit variable expense %+0$000 8 4otal fixed expense
3e calculate the brea/-even point as follo#s9
"ales 8 @ariable expenses ; 2ixed expenses ; >rofits"ales 8 @ariable expenses ; 2ixed expenses ; >rofits
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uation ,etho$
%!00 8 %300 ; %+0$000 ; %0%&00 8 %+0$000 8 %+0$000 E %&00 per bi6e
8 400 bikes400 bikes
3e calculate the brea/-even point as follo#s9
"ales 8 @ariable expenses ; 2ixed expenses ; >rofits"ales 8 @ariable expenses ; 2ixed expenses ; >rofits
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uation ,etho$
!he euation can be mo$ifie$ to calculatethe brea/-even point in sales $ollars%
"ales 8 @ariable expenses ; 2ixed expenses ; >rofits"ales 8 @ariable expenses ; 2ixed expenses ; >rofits
8 0.*0 ; %+0$000 ; 8 0.*0 ; %+0$000 ; %0%0
Dhere 8 4otal sales dollars
0.*0 8 @ariable expenses as a 9 of sales%+0$000 8 4otal fixed expenses
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uation ,etho$
8 0.*0 ; %+0$000 ; %0 0.0 8 %+0$000
8 %+0$000 E 0.0 8 $200,000 $200,000
"ales 8 @ariable expenses ; 2ixed expenses ; >rofits"ales 8 @ariable expenses ; 2ixed expenses ; >rofits
!he euation can be mo$ifie$ to calculatethe brea/-even point in sales $ollars%
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Contribution ,argin ,etho$
!he contribution margin metho$ has t#o/ey euations%
2ixed expensesnit contribution margin
85rea6-even point
in units sold
2ixed expenses CM ratio8
5rea6-even point in
total sales dollars
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Contribution ,argin ,etho$
LetEs use the contribution margin metho$ tocalculate the brea/-even point in total
sales $ollars at Racing%
2ixed expenses CM ratio
85rea6-even point intotal sales dollars
).+'+++).+'+++0+
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>uic/ Chec/
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average *'++cups are sol$ each month% 3hat is the brea/-evensales in units
a% .* cups
b% 4'6 cups
c% '*++ cups
$% '7+ cups
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average *'++cups are sol$ each month% 3hat is the brea/-evensales in units
a% .* cups
b% 4'6 cups
c% '*++ cups
$% '7+ cups
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Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average *'++cups are sol$ each month% 3hat is the brea/-evensales in units
a% .* cups
b% 4'6 cupsc% '*++ cups
$% '7+ cups
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average *'++cups are sol$ each month% 3hat is the brea/-evensales in units
a% .* cups
b% 4'6 cupsc% '*++ cups
$% '7+ cups
>uic/ Chec/
2ixed expensesnit CM
5rea6-even 8
%#$300%#.=cup - %0.3*=cup
%#$300%#.#3=cup
8 1,150 cups
8
8
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>uic/ Chec/
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average *'++cups are sol$ each month% 3hat is the brea/-evensales in $ollars
a% )'4++
b% )'7
c% )'..
$% )4'*@
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average *'++cups are sol$ each month% 3hat is the brea/-evensales in $ollars
a% )'4++
b% )'7
c% )'..
$% )4'*@
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Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average *'++cups are sol$ each month% 3hat is the brea/-evensales in $ollars
a% )'4++
b% )'7c% )'..
$% )4'*@
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% On average *'++cups are sol$ each month% 3hat is the brea/-evensales in $ollars
a% )'4++
b% )'7c% )'..
$% )4'*@
>uic/ Chec/
2ixed expenses
CM 7atio
5rea6-even
sales%#$3000.:!+
8 $1,715
8
8
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Learning Objective
LO6LO6
!o $etermine the level ofsales nee$e$ to achieve a
$esire$ target profit%
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!arget Profit Analysis
!he euation an$ contribution marginmetho$s can be use$ to $etermine the
sales volume nee$e$ to achieve a target
profit%
&uppose Racing Bicycle Company
#ants to /no# ho# many bi/es mustbe sol$ to earn a profit of )++'+++%
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!he CVP uation ,etho$
"ales 8 @ariable expenses ; 2ixed expenses ; >rofits"ales 8 @ariable expenses ; 2ixed expenses ; >rofits
%!00 8 %300 ; %+0$000 ; %#00$000
%&00 8 %#+0$000
8 900 bikes
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!he Contribution ,argin Approach
!he contribution margin metho$ can be use$to $etermine that @++ bi/es must be sol$ to
earn the target profit of )++'+++%
2ixed expenses ; 4arget profit nit contribution margin
8nit sales to attain
the target profit
%+0$000 ; %#00$000 %&00=bi6e
8 900 bikes
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>uic/ Chec/
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% Do# many cups ofcoffee #oul$ have to be sol$ to attain target profitsof )*'7++ per month
a% 4'464 cups
b% *'** cups
c% '7+ cups
$% 0'*++ cups
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% Do# many cups ofcoffee #oul$ have to be sol$ to attain target profitsof )*'7++ per month
a% 4'464 cups
b% *'** cupsc% '7+ cups
$% 0'*++ cups
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Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% Do# many cups ofcoffee #oul$ have to be sol$ to attain target profitsof )*'7++ per month
a% 4'464 cups
b% *'** cupsc% '7+ cups
$% 0'*++ cups
Coffee ?latch is an espresso stan$ in a $o#nto#noffice buil$ing% !he average selling price of a cupof coffee is )%0@ an$ the average variablee"pense per cup is )+%46% !he average fi"e$
e"pense per month is )'4++% Do# many cups ofcoffee #oul$ have to be sol$ to attain target profitsof )*'7++ per month
a% 4'464 cups
b% *'** cupsc% '7+ cups
$% 0'*++ cups
>uic/ Chec/ 2ixed expenses ; 4arget profit
nit CM
nit salesto attain
target profit
8 3$3*3 cups
8%3$+00%#.#3
%#$300 ; %&$!00%#. - %0.3*
8
8
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Learning Objective
LOLO
!o compute the margin ofsafety an$ e"plain its
significance%
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!he ,argin of &afety
!he margin of safety is the e"cess ofbu$gete$ 1or actual2 sales over the brea/-
even volume of sales%
Margin of safety 8 4otal sales - 5rea6-even salesMargin of safety 8 4otal sales - 5rea6-even sales
LetEs loo/ at Racing Bicycle Company an$
$etermine the margin of safety%
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!he ,argin of &afety
(f #e assume that Racing Bicycle Company has actualsales of )*7+'+++' given that #e have alrea$y$etermine$ the brea/-even sales to be )*++'+++'
the margin of safety is )7+'+++ as sho#n
5rea6-even
sales
00 units
Actual sales
!00 units
"ales &00$000% &!0$000%
'ess variable expenses #&0$000 #!0$000 Contribution margin +0$000 #00$000
'ess fixed expenses +0$000 +0$000
,et operating income -% &0$000%
5rea6-even
sales
00 units
Actual sales
!00 units
"ales &00$000% &!0$000%
'ess variable expenses #&0$000 #!0$000 Contribution margin +0$000 #00$000
'ess fixed expenses +0$000 +0$000
,et operating income -% &0$000%
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!he ,argin of &afety
!he margin of safety can be e"presse$ as&09 of sales%
1)7+'+++ F )*7+'+++2
5rea6-even
sales
00 units
Actual sales
!00 units
"ales &00$000% &!0$000%
'ess variable expenses #&0$000 #!0$000 Contribution margin +0$000 #00$000
'ess fixed expenses +0$000 +0$000
,et operating income -% &0$000%
5rea6-even
sales
00 units
Actual sales
!00 units
"ales &00$000% &!0$000%
'ess variable expenses #&0$000 #!0$000 Contribution margin +0$000 #00$000
'ess fixed expenses +0$000 +0$000
,et operating income -% &0$000%
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!he ,argin of &afety
!he margin of safety can be e"presse$ interms of the number of units sol$% !hemargin of safety at Racing is )7+'+++'
an$ each bi/e sells for )7++%
,argin of ,argin of
&afety in units&afety in units== = ++ bi/es= ++ bi/es
)7+'+++)7+'+++
)7++)7++
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>uic/ Chec/
Coffee ?latch is an espresso stan$ in a$o#nto#n office buil$ing% !he average sellingprice of a cup of coffee is )%0@ an$ theaverage variable e"pense per cup is )+%46% !he
average fi"e$ e"pense per month is )'4++% Onaverage *'++ cups are sol$ each month% 3hatis the margin of safety
a% 4'*7+ cups
b% @7+ cups
c% '7+ cups
$% *'++ cups
Coffee ?latch is an espresso stan$ in a$o#nto#n office buil$ing% !he average sellingprice of a cup of coffee is )%0@ an$ theaverage variable e"pense per cup is )+%46% !he
average fi"e$ e"pense per month is )'4++% Onaverage *'++ cups are sol$ each month% 3hatis the margin of safety
a% 4'*7+ cups
b% @7+ cups
c% '7+ cups
$% *'++ cups
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Coffee ?latch is an espresso stan$ in a$o#nto#n office buil$ing% !he average sellingprice of a cup of coffee is )%0@ an$ theaverage variable e"pense per cup is )+%46%
!he average fi"e$ e"pense per month is)'4++% On average *'++ cups are sol$ eachmonth% 3hat is the margin of safety
a% 4'*7+ cups
b% @7+ cups
c% '7+ cups
$% *'++ cups
Coffee ?latch is an espresso stan$ in a$o#nto#n office buil$ing% !he average sellingprice of a cup of coffee is )%0@ an$ theaverage variable e"pense per cup is )+%46%
!he average fi"e$ e"pense per month is)'4++% On average *'++ cups are sol$ eachmonth% 3hat is the margin of safety
a% 4'*7+ cups
b% @7+ cups
c% '7+ cups
$% *'++ cups
>uic/ Chec/
Margin of safety 8 4otal sales ? 5rea6-even sales
8 950 cups
8 &$#00 cups ? #$#!0 cups
or !0 cups
&$#00 cupsMargin of safety
percentage8 8 45%
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Cost &tructure an$ Profit &tability
Cost structure refers to the relative proportionof fi"e$ an$ variable costs in an organiGation%
,anagers often have some latitu$e in
$etermining their organiGationEs cost structure%
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Cost &tructure an$ Profit &tability
!here are a$vantages an$ $isa$vantages to highfi"e$ cost 1or lo# variable cost2 an$ lo# fi"e$ cost
1or high variable cost2 structures%
An a$vantage of a high fi"e$ An a$vantage of a high fi"e$cost structure is that incomecost structure is that income#ill be higher in goo$ years#ill be higher in goo$ years
compare$ to companiescompare$ to companies
#ith lo#er proportion of #ith lo#er proportion of
fi"e$ costs%fi"e$ costs%
An a$vantage of a high fi"e$ An a$vantage of a high fi"e$cost structure is that incomecost structure is that income#ill be higher in goo$ years#ill be higher in goo$ years
compare$ to companiescompare$ to companies
#ith lo#er proportion of #ith lo#er proportion of
fi"e$ costs%fi"e$ costs%
A $isa$vantage of a high fi"e$ A $isa$vantage of a high fi"e$
cost structure is that incomecost structure is that income#ill be lo#er in ba$ years#ill be lo#er in ba$ yearscompare$ to companiescompare$ to companies#ith lo#er proportion of #ith lo#er proportion of
fi"e$ costs%fi"e$ costs%
A $isa$vantage of a high fi"e$ A $isa$vantage of a high fi"e$
cost structure is that incomecost structure is that income#ill be lo#er in ba$ years#ill be lo#er in ba$ yearscompare$ to companiescompare$ to companies
#ith lo#er proportion of #ith lo#er proportion of
fi"e$ costs%fi"e$ costs%
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Learning Objective
LO.LO.
!o compute the $egree of
operating leverage at aparticular level of sales an$
e"plain ho# it can be use$ topre$ict changes in net
operating income%
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Operating Leverage
Contribution margin,et operating income
Fegree of operating leverage
=
A measure of hoG sensitive net operatingincome is to percentage changes in sales.
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Operating Leverage
Actual sales
!00 5i6es
"ales &!0$000%'ess variable expenses #!0$000
Contribution margin #00$000
'ess fixed expenses +0$000
,et income &0$000%
Actual sales
!00 5i6es
"ales &!0$000%'ess variable expenses #!0$000
Contribution margin #00$000
'ess fixed expenses +0$000
,et income &0$000%
%#00$000
%&0$000
8 5 5
At Racing' the $egree of operating leverage is7%
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Operating Leverage
3ith an operating leverage of 7' if Racing3ith an operating leverage of 7' if Racingincreases its sales by +
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Operating Leverage
10% increase in sales from$250,000 to $275,000 . . .
10% increase in sales from$250,000 to $275,000 . . .
. . . results in a 50% increase in
income from $20,000 to $30,000.
. . . results in a 50% increase in
income from $20,000 to $30,000.
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>uic/ Chec/
Coffee ?latch is an espresso stan$ in a$o#nto#n office buil$ing% !he average sellingprice of a cup of coffee is )%0@ an$ theaverage variable e"pense per cup is )+%46%
!he average fi"e$ e"pense per month is)'4++% On average *'++ cups are sol$ eachmonth on% 3hat is the operating leverage
a% *%*
b% +%07c% +%40
$% *%@*
Coffee ?latch is an espresso stan$ in a$o#nto#n office buil$ing% !he average sellingprice of a cup of coffee is )%0@ an$ theaverage variable e"pense per cup is )+%46%
!he average fi"e$ e"pense per month is)'4++% On average *'++ cups are sol$ eachmonth on% 3hat is the operating leverage
a% *%*
b% +%07c% +%40
$% *%@*
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Coffee ?latch is an espresso stan$ in a$o#nto#n office buil$ing% !he average sellingprice of a cup of coffee is )%0@ an$ theaverage variable e"pense per cup is )+%46%
!he average fi"e$ e"pense per month is)'4++% On average*'++ cups are sol$ eachmonth% 3hat is the operating leverage
a% *%*
b% +%07c% +%40
$% *%@*
Coffee ?latch is an espresso stan$ in a$o#nto#n office buil$ing% !he average sellingprice of a cup of coffee is )%0@ an$ theaverage variable e"pense per cup is )+%46%
!he average fi"e$ e"pense per month is)'4++% On average*'++ cups are sol$ eachmonth% 3hat is the operating leverage
a% *%*
b% +%07c% +%40
$% *%@*
>uic/ Chec/
Contribution margin,et operating income
peratingleverage 8
%&$3:3%#$0:38 8 2.21
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>uic/ Chec/
At Coffee ?latch the average selling price of a At Coffee ?latch the average selling price of acup of coffee is )%0@' the average variablecup of coffee is )%0@' the average variablee"pense per cup is )+%46' an$ the average fi"e$e"pense per cup is )+%46' an$ the average fi"e$e"pense per month is )'4++% On average *'++e"pense per month is )'4++% On average *'++
cups are sol$ each month%cups are sol$ each month%(f sales increase by *+
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At Coffee ?latch the average selling price of a At Coffee ?latch the average selling price of acup of coffee is )%0@' the average variablecup of coffee is )%0@' the average variablee"pense per cup is )+%46' an$ the average fi"e$e"pense per cup is )+%46' an$ the average fi"e$e"pense per month is )'4++% On average *'++e"pense per month is )'4++% On average *'++
cups are sol$ each month%cups are sol$ each month%(f sales increase by *+
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Verify (ncrease in Profit
Actualsales
Increasedsales
2,100 cups 2,520 cups
"ales 3$#&% 3$:!!%
'ess @ariable expenses :!* 0: Contribution margin &$3:3 &$++
'ess 2ixed expenses #$300 #$300
,et operating income #$0:3% #$!+%9 change in sales &0.09
9 change in net operating income .&9
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&tructuring &ales Commissions
Companies generally compensatesalespeople by paying them either a
commission base$ on sales or a salary plus a
sales commission% Commissions base$ onsales $ollars can lea$ to lo#er profits in a
company%
LetEs loo/ at an e"ample%LetEs loo/ at an e"ample%
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&tructuring &ales Commissions
Pipeline Hnlimite$ pro$uces t#o types of surfboar$s'the IR an$ the !urbo% !he IR sells for )++ an$generates a contribution margin per unit of )*7% !he!urbo sells for )7+ an$ earns a contribution margin
per unit of ).%
!he sales force at Pipeline Hnlimite$ is
compensate$ base$ on sales commissions%
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&tructuring &ales Commissions
(f you #ere on the sales force at Pipeline' you #oul$push har$ to sell the !urbo even though the IR
earns a higher contribution margin per unit%
!o eliminate this type of conflict' commissions cancommissions can
be based on contribution marginbe based on contribution margin rather than onselling price alone%
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Learning Objective
LO@LO@
!o compute the brea/-even
point for a multipro$uctcompany an$ e"plain the
effects of shifts in the salesmi" on contribution margin
an$ the brea/-even point%
C f &
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!he Concept of &ales ,i"
&ales mi" is the relative proportion in #hich acompanyEs pro$ucts are sol$%
8ifferent pro$ucts have $ifferent sellingprices' cost structures' an$ contribution
margins%
LetEs assume Racing Bicycle Company sells
bi/es an$ carts an$ that the sales mi"bet#een the t#o pro$ucts remains the same%
, l i $ b / l i
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,ulti-pro$uct brea/-even analysis
Racing Bicycle Co% provi$es the follo#ing information9
%&*!$000
%!!0$000
8 +.&9 (rounded)
, lti $ t b / l i
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,ulti-pro$uct brea/-even analysis2ixed expenses
CM 7atio
5rea6-even
sales%#:0$000
+.&9
8 $352,697
8
=
? A ti f CVP A l i
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?ey Assumptions of CVP Analysis
&elling price is constant%&elling price is constant%Costs are linear%Costs are linear%
(n multi-pro$uct companies' the(n multi-pro$uct companies' the
sales mi" is constant%sales mi" is constant%
(n manufacturing companies'(n manufacturing companies'
inventories $o not change 1unitsinventories $o not change 1unitspro$uce$ = units sol$2%pro$uce$ = units sol$2%
$ f Ch t 6
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n$ of Chapter 6
Recommended