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BAAC 221 Chapter 7

Cost-Volume Profit Analysis

QuestionAnswer
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
Created by: 1229955762