Cost-Volume-Profit Relationships
The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
The Basics of Cost-Volume-Profit (CVP) AnalysisContribution
Margin (CM) is the amount remaining from sales revenue after
variable expenses have been deducted.
Sheet1
WIND BICYCLE CO.
Contribution Income Statement
For the Month of June
TotalPer Unit
Sales (500 bikes)$250,000$500
Less: variable expenses150,000300
Contribution margin100,000$200
Less: fixed expenses80,000
Net income$20,000
Sheet2
Sheet3
The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
The Basics of Cost-Volume-Profit (CVP) AnalysisCM goes to cover
fixed expenses.
Sheet1
WIND BICYCLE CO.
Contribution Income Statement
For the Month of June
TotalPer Unit
Sales (500 bikes)$250,000$500
Less: variable expenses150,000300
Contribution margin100,000$200
Less: fixed expenses80,000
Net income$20,000
Sheet2
Sheet3
The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
The Basics of Cost-Volume-Profit (CVP) AnalysisAfter covering
fixed costs, any remaining CM contributes to income.
Sheet1
WIND BICYCLE CO.
Contribution Income Statement
For the Month of June
TotalPer Unit
Sales (500 bikes)$250,000$500
Less: variable expenses150,000300
Contribution margin100,000$200
Less: fixed expenses80,000
Net income$20,000
Sheet2
Sheet3
The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
The Contribution ApproachThe break-even point can be defined
either as:The point where total sales revenue equals total expenses
(variable and fixed).The point where total contribution margin
equals total fixed expenses.
The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
Contribution Margin RatioThe contribution margin ratio is: For
Wind Bicycle Co. the ratio is:
The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
CVP Relationships in Graphic FormViewing CVP relationships in a
graph gives managers a perspective that can be obtained in no other
way. Consider the following information for Wind Co.:
Sheet1
Income 300 unitsIncome 400 unitsIncome 500 units
Sales$150,000$200,000$250,000
Less: variable expenses90,000120,000150,000
Contribution margin$60,000$80,000$100,000
Less: fixed expenses80,00080,00080,000
Net income (loss)$(20,000)0.0$20,000
&A
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The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
CVP GraphFixed expensesUnitsDollarsTotal Expenses
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FC
TC
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The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
UnitsDollarsCVP GraphTotal Sales
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FC
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The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
UnitsDollarsCVP GraphBreak-even pointProfit AreaLoss Area
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The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
The Margin of SafetyExcess of budgeted (or actual) sales over
the break-even volume of sales. The amount by which sales can drop
before losses begin to be incurred.Margin of safety = Total sales -
Break-even salesLets calculate the margin of safety for Wind.
The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
Operating LeverageA measure of how sensitive net income is to
percentage changes in sales.With high leverage, a small percentage
increase in sales can produce a much larger percentage increase in
net income.
The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
Operating LeverageWith a measure of operating leverage of 5, if
Wind increases its sales by 10%, net income would increase by
50%.Heres the proof!
Sheet1
Percent increase in sales10%
Degree of operating leverage5
Percent increase in profits50%
&A
Page &P
The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
The Concept of Sales MixSales mix is the relative proportions in
which a companys products are sold.Different products have
different selling prices, cost structures, and contribution
margins. Lets assume Wind sells bikes and carts and see how we deal
with break-even analysis.
The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
Assumptions of CVP AnalysisSelling price is constant throughout
the entire relevant range.Costs are linear throughout the entire
relevant range.In multi-product companies, the sales mix is
constant.In manufacturing companies, inventories do not change
(units produced = units sold).
The McGraw-Hill Companies, Inc., 2002Irwin/McGraw-Hill *
End of Chapter 6
