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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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