Class Meeting 6

COST-VOLUME-PROFIT (CVP) ANALYSIS

Riwayadi
1
5 variables in CVP
Variable Cost
Fixed cost
Volume or units sold
Profit
price

2
Managerial uses of CVP analysis
To determine the BEP (break even point)
To achieve the targeted profit before tax
and after tax
Engineering the CVP variables

3
 LO 1

COST-VOLUME-PROFIT (CVP)

CVP expresses:
# units that must be sold to break even
Impact of a given reduction in fixed costs on
break-even point
Impact of an increase in price on profit
Sensitivity analysis of impact of various price or
cost levels on profit

4
 LO 1

BREAK-EVEN
BREAK-EVEN POINT:
POINT: Definition
Definition

BEP is a condition in which

the company is not getting a
profit or a loss

It happens where total revenue

equals total cost; the point of
zero profit.
zero profit
5
 LO 1

FORMULA: Operating Income

Operating income includes revenues &

expenses from the firm’s normal
operations (before tax).

Operating Income
= Sales revenue
– Variable expenses
– Fixed expenses
6
 LO 1

NET
NET INCOME:
INCOME: Definition
Definition

Is operating income minus

income taxes.

7
 LO 1

FORMULA: Break-Even
Illustration

Break-even is 0 profit. VC/unit $ 325

Price/unit $ 400
Fixed cost for year $ 45.000
Determine BEP in unit or $

1) Break-even (using equation method):

0 = Sales revenue – Variable expenses – Fixed expenses
0 = (units sold x price) – (units sold x vc/unit) – Fixed expenses
0 = (400 x Q) – (325 x Q) - $45,000 Q=units sold
75 Q = $45,000
8
Q = 600 or in total $ 240,000 => 600 units x $ 400
 LO 1

WHITTIER CO.: √√Income

WHITTIER CO.: Income Statement
Statement

√Check-up on break-even
Sales (600 units @ $400) $ 240,000
Less: Variable expenses (600 x 325) 195,000
Contribution margin (600 units x $ 75) $ 45,000
Less: Fixed expenses 45,000
Operating income $ 0

9
 LO 1

CONTRIBUTION
CONTRIBUTION MARGIN:
MARGIN:
Definition
Definition

Is sales revenue minus variable

costs.

10
 LO 1

FORMULA: Break-Even

Break-even using contribution margin (short cut method).

2) CM per unit method (to determine BEP in

units):
# Units = Fixed cost / Unit contribution margin
# units = FC / (Price per unit – VC per unit)
# Units = $45,000 / ($400 - $325)
= 600 or $ 240.000 (600 units x $ 400)

11
 LO 1

FORMULA: Target Profit % Sales

Targeted profit: profit that is desired for period. Targeted profit can
Be calculated as % of sales (profit margin) or % of asset (ROA)

Target profit can be calculated as % of revenue.

Target profit as 15% of sales: Proof:
Sales: 3.000 x 400 1.200.00
0.15 ($400Q) = VC: 3.000 x 325 975.000
CM: 3.000 x 75 225.000
($400 x Q) – ($325 x Q) - $45,000 FC 45.000
Operating income 180.000
60Q = 400Q – 325Q - $45,000 Targeted proft:
180.000/1.200.000 x 100% =
15Q = 45.000 15% of sales

Q= 3,000
12
Target profit is calculated as % of asset
Total asset $ 1.000.000
ROA = 20%
Target profit: 20% x 1.000.000 = $ 200.000
Sales (in unit) = FC + target profit before tax
or in $ ----------------------------------
CM per unit or CM ratio
Sales (in units) = 45.000 + 200.000 / (400 – 325)
= 245.000 / 75
= 3.267 units
13
 LO 2

VARIABLE
VARIABLE COST
COST RATIO:
RATIO:
Definition
Definition

Is the proportion of each sales

dollar used to cover variable
costs.

14
 LO 2

CONTRIBUTION
CONTRIBUTION MARGIN
MARGIN RATIO:
RATIO:
Definition
Definition

Is the proportion of each sales

dollar available to cover fixed
costs & provide profit.

15
 LO 2

WHITTIER
WHITTIER CO.:
CO.: Background
Background

CMR for mulching lawn mower.

Sales (1,000 units @ $400) $ 400,000 100.00%
Less: Variable expenses 325,000 81.25%
Contribution margin $ 75,000 18.75%
Less: Fixed expenses 45,000
Operating income $ 30,000

16
 LO 2

FORMULA: Break-Even CMR

3) CM Ratio Method

Contribution margin ratio (CMR) is

used to find BEP in Dollar

Break-even Sales = Fixed cost / CMR

= FC / (1 – (VC per unit / Price per unit))

BEP (in $) = $45,000 / (1 – (325 / 400))

= $ 45.000 / 0.1875
= $ 240.000 or 600 units (240.000 / 400)
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 CM
Margin or profit available for covering the FC
and obtaining the operating income

18
 CM PER UNIT
 CM per unit = marginal income (income coeficient) 
additional income for each units sold
 Based on previous illustration, what is the profit or loss if
sales are:
 600 units => BEP
 601 units => profit $ 75
 599 units => loss $ 75
 No unit sold => loss $ 45.000 (as much as FC)
 700 units => profit: (700 – 600) 75 = $ 7.500
 1 units => loss: 45.000 – 75 =
Formula: Profit (loss) = 75 x – 45.000
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 TARGET PROFIT AFTER TAX
Sales (in units or $) =
FC + (Target profit after tax / (1 – tax rate))
---------------------------------------------------
CM per unit or CM ratio

20
NIAT = NIBT – Tax
NIAT = NIBT – (NIBT x Tax rate)
NIAT = NIBT (1 – Tax rate)
NIBT (1 – tax rate) = NIAT
NIBT = NIAT / 1 – tax rate
If NI after tax desired $ 200.000, how many units
should be sold? Tax rate 20%
Sales in Units =
(45.000 + (200.000 / 1 – 0.20)) / (400 – 325)
(45.000 + 250.000) / 75 = 3.933 units
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 exercise
Selling price per unit $ 5.000
Variable cost per unit $ 3.000
Fixed cost per year $ 10.000.000
1.How many units should be sold to achieve BEP?
2.How many units should be sold to achieve target
profit before tax $ 800.000
3.How many units should be sold to achieve target
profit after tax $ 800.000. tax rate 20%
22
 3 kinds of CVP Graph
TR line
Sales / cost Total cost line
Profit

BEP
$ 25 M
Total Cost
VC
$ 10 M FC line
Loss
FC

Q sold
5.000

23
 CVP Graph with CM Area
TR line
Sales / cost
Profit Total cost line

BEP VC line
CM Area
$ 25 M
FC
$ 10 M
Loss Total Cost

VC
Q sold
5.000

24
 Profit and loss
Profit
graph
Profit/loss = 2000X – 10.000.000

2M
BEP Profit
Q Sold
5.000 6.000
Loss

10 M
Loss
25
 Quiz 15 minutes (page 32 on handout)
Costs for one-day seminar are as follows:
Seminar kits Rp 10.000 per participant
Snack/lunch Rp 30.000 per participant
Speakers Rp 1.000.000
Seminar room rent expense Rp 2.000.000
Committee fees Rp 500.000
Certificate Rp 5.000 per participant
Seminar contribution / fees Rp 85.000 per participant
1. How many participants must attend the seminar to achieve
the BEP?
2. How many participants must attend the seminar to achieve
the targeted profit before tax Rp 400.000
3. How many participants must attend the seminar to achieve
the targeted profit after tax Rp 400.000. Tax rate 20%
4. If available (normal) capacity of seminar room is 80 seats,
what are you going to do to achieve the BEP?

26
 Class Meeting 7

COST-VOLUME-PROFIT (CVP) ANALYSIS

Riwayadi
27
 LO 3

APPLICATION OF CVP ANALYSIS IN

MULTIPRODUCT COMPANY

Can we use CVP if

company has more than 1
product?
Yes. But we have to add
direct
directfixed
fixedexpenses
expenses into
the analysis and sales mix

28
 LO 3

DIRECT
DIRECT FIXED
FIXED EXPENSES:
EXPENSES:
Definition
Definition

Are fixed costs that can be

traced to each product and
would be avoided if the product
did not exist.

29
 INDIRECT FIXED EXPENSES
(COMMON FIXED COSTS)
Cost that can not be traced to each products
and would not be avoided even though the
product is dropped
Common fixed costs => unavoidable cost
Avoidable cost => cost that will
disappear/vanish because of choosing
alternatives
Unavoidable cost => cost still exists whatever
the alternatives are chosen
30
SALES MIX
Composition of each product
sold. For example, each two
units of product A are sold,
three units of product B are
sold. Sale mix will be 2:3

31
 Illustration
Mulching Riding
Sale mix 3 2
Price 400 800
Variable cost 325 600
Direct FC per year 30.000 40.000
Common fixed cost $ 26.250
1. Determine the BEP for each product?
2. Determine the company’s BEP

32
 BEP for EACH PRODUCT
Mulching: direct FC / CM per unit
30.000 / 400 – 325 = 400 units
Riding: 40.000 / 800 – 600 = 200 units
If we sell for these units, how much will the
company be loss? $26.250 (as much as
common fixed cost)

33
 LO 3

WHITTIER
WHITTIER CO.:
CO.: Sales
Sales Mix
Mix &
& CVP
CVP
Background
Background

Margin for multiple products

Unit Unit Package Margin*
Product Price VC CM Cont. Mix (package
CM)
Mulching $400 $325 $ 75 3 $ 225
Riding 800 600 200 2 400
Package Total $ 625
*Margin = Units in package x CM

34
 LO 3

FORMULA: Break-Even Packages

Contribution margin approach to

multiple products.

Break-even packages = Fixed cost / Package CM

= (direct FC + common FC) / Package CM
= $96,250 / $625
= 154 Packages
Mulching: 154 x 3 = 462 units or 462 x $ 400 = $ 184.800
Riding: 154 x 2 = 308 units or 308 x $ 800 = $246.400

35
 LO 3

BREAK-EVEN SOLUTION
Mulching mower sales =
$400 x 3 x 154 packages.

EXHIBIT 11-1
36
 Another Alternative
BEP = Total FC / Average CM per unit
or Average CM ratio

37
 LO 3

WHITTIER
WHITTIER CO.:
CO.: Sales
Sales Mix
Mix &
& CVP
CVP
Background
Background

Margin for multiple products

sale VC in
Product in sale sales CM Sale Mix Average
mix mix

Mulching (3) $1.200 $975 $ 225 5 45

Riding (2) 1.600 1.200 400 5 80
Total 625 5 $ 125
BEP = 96.250 / 125 = 770 units
Mulching: 3/5 x 770 units = 462 units x $ 400 = $ 184.800
Riding: 2/5 x 770 units = 308 units x $ 800 = $ 246.400 38
 Mulching Riding Total Sales Mix Average Ratio

Sales 1.200 1.600 2.800 5 560 1

VC 975 1.200 2.175 5 435 ?
CM 225 400 625 5 125 22,32%

BEP: 96.250 / 0,2232 = Rp 431.200

Sales for:
Mulching: 1.200/2.800 x Rp 431.200 = Rp184.800
Riding: 1.600 / 2.800 x Rp 431.200 = Rp 246.400

39
 exercise
Corn Chips Potato Chips
Sales mix 7 3
Price per unit Rp 3.000 Rp 5.000
VC per unit Rp 1.000 Rp 2.000
Direct FC for year Rp 5.000.000 Rp 8.000.000
Common FC for year Rp 10.000.000
Required:
1.How many units should be sold for each kind of
product to achieve the company’s BEP?
2.How many units should be sold for each kind of
product to achieve targeted profit before tax of Rp
2.300.000
3.Using units sold on question (2), prepare income
statement
40
 LO 4

ASSUMPTIONS OF CVP
CVP analysis assumes
Linear revenue & cost functions
Price, total fixed costs, & unit variable costs can
be accurately identified & remain constant over the
relevant range
What is produced is sold
Sales mix is known and sales mix is constant
Selling prices & costs are known with certainty

41
 LO 4

COST-PROFIT-VOLUME GRAPH
Yes. CVP will apply so
long as the cost &
revenue functions are
approximately linear over
the relevant range.

EXHIBIT 11-4b
42
 LO 5

What can Whittier do to

increase sales of mulching
mowers?

Sales can be increased by some

combination of increased
advertising and decreased
prices.

43
 LO 5

ALTERNATIVES
Assuming
Assumingthat
thatselling
sellingprice
priceper
perunit
unit$$400,
400,variable
variablecost
cost
per
perunit
unit$$325,
325,and
andfixed
fixedcost
costper
peryear
year$$30.000
30.000
#1
#1IfIfadvertising
advertisingexpenditures
expendituresincrease
increaseby by$8,000,
$8,000,sales
saleswill
will
increase
increasefrom
from1,600
1,600toto1,725
1,725units.
units.
#2
#2AAprice
pricedecrease
decreasefrom
from$400
$400toto$375
$375perperunit
unitwill
willincrease
increase
sales
salesfrom
from1,600
1,600toto1,900.
1,900.
#3
#3Decreasing
Decreasingprice
pricetoto$375
$375and
andincreasing
increasingadvertising
advertising
expenditures
expendituresby by$8,000
$8,000will
willincrease
increasesales
salesfrom
from1,600
1,600toto
2,600
2,600units.
units.
Which
Whichalternative
alternativewill
willyou
youchoose?
choose?

44
Assuming that selling price per unit $ 400, variable cost per
unit $ 325, and fixed cost per year $ 30.000

Alter 1: Price per unit is decreased by

5%
Alter 2: variable cost per unit is
decreased by 20%
Alter 3, fixed cost is decreased by 20%
Alter 4, price per unit increases by 20%
and fixed cost increases by 20%
Which alternative will you choose?
45
Selling price per unit $ 500
Variable cost per unit $ 300
Fixed cost per year $ 1.000.000
If the company desires targeted profit for $
400.000, and sale volume of 6.000 units,
how many percent should variable cost per
unit be reduced? Assuming selling price per
unit and fixed cost remain constant
46
 2011 2012
Sales ............ $ 5.000.000 ?
Variable cost 2.000.000 ?
CM $ 3.000.000 ?
FC $ 2.500.000 ?
Operating income$ 500.000 800.000
Required:
1.Determine the BEP in dollar
2.Determine the 2012 sales in dollar to achive targeted profit before
tax $ 800.000.
3.Prepare income satement for 2012

47
 MARGIN OF SAFETY (MOS)
 MOS is a risk measure
 The greater the MOS, the lower the risk, and vice versa
 MOS is the maximum percentage of sales can decrease in
order the company is not getting a loss
(Targeted Sales – BEP)
MOS = ---------------------------- x 100%
Targeted sales
Targeted sales = 1.000 units, BEP 600 units, MOS? What does it
mean?
MOS = 400 / 1000 x 100% = 40%
In a bad economic condition, if sales decrease by 40%, the
company is not still getting a loss.
48
 Degree of Operating Leverage
(DOL)
 Leverage: dongkrak. Apa filosopi dongkrak? Dengan
sedikit tenaga, dapat mengangkat benda yang besar
 Operating leverage: by increasing less sales, more
profit can be increased
 DOL = CM / OI = …. Times
 If DOL = 8 x, increase in sales by 20%, profit will
increase by 160%. Otherwise, if decrease in sales by
20%, profit will decrease by 160%.
 DOL is also risk measure. The greater the DOL, the
higher the risk, the easier to increase the profit, and
vice versa

49
 LO 5

How should Whittier use

the results of analysis in
the 3 alternatives?

Whittier should consider its

choice in the context of Risk &
risk & Uncertainty.
uncertainty.

50
 LO 5

RISK & UNCERTAINTY

For
ForWhittier,
Whittier,risk
riskincludes
includesthethefact
factthat
thatprices
pricesand
and
costs
costscan
cannot
notbe
bepredicted
predictedwithwithcertainty.
certainty.Risk
Risk
assumes
assumesthat
thatthe
thedistributions
distributionsof ofthe
thevariables
variables
ininquestion
questionare
areknown
known(i.e.,
(i.e.,we
weknow
knowhowhow
sales
saleswill
willreact
reactininresponse
responsetotochanges
changesininprice
price
ororcost).
cost).Under
Underuncertainty,
uncertainty,these
thesedistributions
distributions
are
arenot
notknown.
known.

51
 LO 5

SENSITIVITY
SENSITIVITY ANALYSIS:
ANALYSIS:
Definition
Definition

Is the use of “what if” to

examine the impact of changes
in underlying assumptions on
operating results.

52
 LO 5

SENSITIVITY ANALYSIS
Under 2 systems, the same
change in price will have
different effects on elements
of CVP, & response to risk
& uncertainty.

EXHIBIT 11-8
53
 LO 6

ABC & CVP

ABC
ABCdivides
dividescosts
costsinto
intounit-based
unit-based&
&
non-unit-based
non-unit-basedcategories.
categories.CVP
CVP
has
hasto
toadjust
adjustits
itsformulas
formulastoto
incorporate
incorporatethis
thisdivision.
division.

54
 LO 6

What are the strategic

implications of the 2
approaches to analyzing
CVP?

An ABC approach to CVP allows

for a better defined breakdown of
costs to analyze alternative
recommendations.

55
CASE
Gosnell Company produces two products: squares and circles. The
projected income for the coming year, segmented by product line,
follows:
Squares Circles Total
Sales $300,000 $2,500,000 $2,800,000
Less: Variable expenses 100,000 500,000 600,000
Contribution margin $200,000 $2,000,000 $2,200,000
Less: Direct fixed expenses 28,000 1,500,000 1,528,000
Product margin $172,000 $ 500,000 $ 672,000
Less: Common fixed expenses 100,000
Operating income $ 572,000

56
The selling prices are $30 for squares and $50 for circles.
Required
a.Compute the number of units of each product that must be sold for
Gosnell Company to break even.
b.Compute the revenue that must be earned to produce an operating
income of10 percent of sales revenues.
c.Assume that the marketing manager changes the sales mix of the
two products so that the ratio is three squares to five circles. Repeat
Requirements 1 and 2.
d.Refer to the original data. Suppose that Gosnell can increase the
sales of squares with increased advertising. The extra advertising
would cost an additional $45,000, and some of the potential purchasers
of circles would switch to squares. In total, sales of squares would
increase by 15,000 units, and sales of circles would decrease by 5,000
units. Would Gosnell be better off with this strategy?

57
THE
THE END
END

58