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BAAC 221 Chapter 7
Cost-Volume Profit Analysis
| Question | Answer |
|---|---|
| Cost-Volume Profit Analysis | expresses the relationships among cost, profit, and volume. (CVP) |
| What assumptions must be met for CVP to be accurate? | 1- change in volume ONLY thing affecting costs 2- each cost can be classified as variable/fixed; linear through relevant range 3- revenue linear in relevant range 4- Inventory levels constant 5- sales mix constant |
| Sales Mix | combination of products that make up total sales. |
| What does contribution margin tell you? | How much revenue is left after variable expenses to CONTRIBUTE to fixed costs |
| Contribution Margin Per Unit Equation | selling price per unit / variable cost per unit |
| Contribution Margin Ratio | the percentage of each sales dollar that is available for covering fixed expenses and generating profit |
| Contribution Margin Ratio Equation | CMR = unit CM / sales price per unit CMR= CM / sales revenue |
| Income Statement Approach to Breakeven | Sales revenue - variable expenses - fixed expense = operating income |
| Breakeven point | where operating income is zero |
| Shortcut Approach to Breakeven | Sales in units = (fixed expenses + operating income) / contribution margin PER UNIT |
| What happens when a company achieves breakeven? | each additional unit sold contributes its unique unit contribution margin directly to profit |
| Shortcut Breakeven Sales in Dollars | Sales in dollars = (fixed expenses + Operating Income) / Contribution margin ratio |
| Sensitivity Analysis | a "what-if" technique that asks what the results will be if actual prices or costs change or if an underlying assumption like sales mix changes |
| New Sales Price Equation | New sales price per unit - variable cost per unit = new contribution margin per unit |
| If sales price decrease then? | unit CM decreases volume need to breakeven increases |
| If sales price increases then? | unit CM increases volume needed to breakeven decreases |
| If variable costs increase? | unit CM decreases volume need to breakeven increases |
| If variable costs decrease? | unit CM increases volume needed to break even decreases |
| If fixed costs increase? | Volume needed to breakeven increases |
| If fixed costs decrease? | Volume needed to breakeven decreases |
| Sales total equation for a multi-product company | Sales total (units) = (fixed + operating inc) / (weighted-average contribution margin per unit) |
| Weighted-Average Contribution Margin Per Unit | Total Contribution Margin for all products / sales mix |
| Margin of Safety | excess of actual or expected sales over breakeven sales. Used to assess risk |
| Margin of safety in units equation | margin of safety in units = expected sales units - breakeven sales units |
| Margin of safety in dollars equation | expected sales in dollars - breakeven sales in dollars |
| Margin of safety as a percentage equation | margin of safety in units or dollars / expected sales in units or dollars |
| Operating Leverage | refers to the relative amount of fixed and variable costs that make up total costs |
| Characteristics of High Operating level Companies | HIGHER fixed costs LOWER variable costs HIGHER contribution margin ratio |
| Effects of volume changes on High Operating level companies | HIGHER risk Higher potential for reward |
| Operating Leverage Factor | tells how responsive a company's operating income is to changes in volume |
| Operating Leverage Factor Equation | OLF = Contribution margin / Operating Income |
| What is the lowest possible operating leverage factor? | 1. occurs when there are no fixed costs |
| Indifference Point | point at which the choices between cost structures are irrelevant because they result in the same total cost |
| Rule for choosing cost structure | choose the LOWER operating leverage option when sales volume is LOWER than indifference point Choose HIGHER operating leverage option when sales volume is HIGHER than indifference point |
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