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CVP Analysis
1
Uses o
f the Contribution Format
Uses o
t^
e Co
t^
but o
o
at
Th
t ib ti
i^
t t
t f
t i
d
Th
t ib ti
i^
t t
t f
t i
d
Th
e contribution income statement format is used The contribution income statement format is used
as an internal planning and decision making tool.as an internal planning and decision making tool.Thi
h i
f l f
Thi
h i
f l f
This approach is useful for:This approach is useful for: 1.1. Cost
Cost-
-volumevolume-
-profit analysisprofit analysisp
y
p^
y
2.2. Budgeting
Budgeting 3.3. Segmented reporting of profit
Segmented reporting of profit data
data
Special decisions s ch as pricing and makeSpecial decisions s ch as pricing and make or
or
4.4. Special decisions such as pricing and make
Special decisions such as pricing and make-
-oror-
buybuy analysis
analysis
2
The Contribution Format
Used primarily forUsed primarily forexternal reportingexternal reporting
Used primarily byUsed primarily by
managementmanagement
external reporting.external reporting.
management.management.
3
The Contribution Format
Total
Unit
Total
Unit
Sales Revenue
100, $^
50 $
Less: Variable costs
60 000
30
Less: Variable costs
60,
30
Contribution margin
40, $^
20 $
Less: Fixed costs
30,
Net operating income
10, $
Th
t ib ti
i^
f^
t^
h^
i
Th
t ib ti
i^
f^
t^
h^
i
Th
e contribution margin format emphasizes The contribution margin format emphasizes cost behavior. Contribution margin covers fixedcost behavior. Contribution margin covers fixed
t^
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id
f^
i
t^
d^
id
f^
i
costs and provides for income.costs and provides for income.
4
COST-VOLUME-PROFIT ANALYSIS
I/S
_______ Bike
_______ Bikes
_______ Bikes
Sales Variable CostsContribution MarginFixed CostsNet Income
I/S
_______ Bikes
_______ Bikes
_______ Bikes
Sales Variable CostsContribution MarginFixed CostsNet Income
Contribution Margin Ratio
O
i^
t^
f^
it^
th
t ib ti
i^
ti
i
O
r, in terms of
units
, the contribution margin
ratio
is:
Unit CM
CM Ratio = For Racing Bicycle Company the ratio is:
Unit selling price
CM Ratio = For Racing Bicycle Company the ratio is:
$200$200$
= 40%
10
Contribution Margin Ratio
400 Bikes
500 Bikes
Sales
200, $^
250,000$
Less: variable expenses
120,
150,
Contribution margin
80,
100,
L^
fi^
d^
80 000
80 000
Less: fixed expenses
80,
80,
Net operating income
$^
20, $
A $50,000 increase in sales revenueA $50,000 increase in sales revenueresults in a $20 000 increase in CMresults in a $20 000 increase in CMresults in a $20,000 increase in CM.results in a $20,000 increase in CM.
($50,000($50,000 ×
× 40% = $20,000)
40% = $20,000)
11
Break-Even Analysis
Here is the information from Racing Bicycle Company:
Total
Per Unit
Percent
Sales (500 bikes)
250,000$
500 $^
100%
Less: variable expenses
150 000
300
60%
Less: variable expenses
150,
300
60%
Contribution margin
100,000$
200 $^
40%
Less: fixed expenses
80,
Net operating income
20, $
12
Contribution Margin Method
The contribution margin method has twoThe contribution margin method has two
key equations.
Fi
d
B
k^
i^
Fi
xed expensesCM per unit
=
Break-even point
in units sold
Fixed expenses
CM ratio
=
Break-even point intotal sales dollars
CM ratio
13
Contribution Margin Method
Let
’s use the contribution margin method Let s use the contribution margin method
to calculate the break-even point in total
sales dollars at Racing.
Fi
d
Break
even point in
Fi
xed expenses
CM ratio
=
Break-even point intotal sales dollars $80,000$80,
= $200,000 break= $200,000 break-
-even saleseven sales
$ 00,000 b ea$ 00,000 b ea
e e
sa es
e e
sa es
14
Target Profit Analysis
Suppose Racing Bicycle Company wantsSuppose Racing Bicycle Company wants
to know how many bikes must be sold
y
to earn a profit of $100,000.
15
The Contribution Margin Approach The contribution margin method can beThe contribution margin method can be used to determine that 900 bikes must be
f^
f $100 000
sold to earn the target profit of $100,000.
Fi
d^
+^
T^
t^
fit
U^
it^
l^
t^
tt i
Fi
xed expenses + Target profit
CM per unit
=
Unit sales to attainthe target profit$80,000 + $100,
$200/bik
=
900 bikes
$200/bike
900 bikes
16
The Margin of Safety
Th
i^
f^
f t
i^
th
f
Th
e margin of safety is the excess ofbudgeted (or actual) sales over the
break-even volume of sales.
M
i^
f^
f t
T t l
l^
B
k^
l
M
argin of safety = Total sales - Break-even sales^ Let’s look at Racing Bicycle Company and
determine the margin of safety.
g
y
17
Operating Leverage
At Racing the degree of operating leverage is 5
Actual sales
At Racing
, the degree of operating leverage is 5.
500 Bikes
Sales
250, $
Less: variable expenses
150,
Contribution margin
100,
Less: fixed expenses
80,
Net income
20, $
$100,
=
5
,
$20,
=
5
22
Operating Leverage
With an operating leverage of 5 if RacingWith an operating leverage of 5 if RacingWith an operating leverage of 5
, if Racing
With an operating leverage of 5, if Racingincreases its sales by 10%, net operatingincreases its sales by 10%, net operating
income
o ld increase b
50%
income
o ld increase b
50%
income would increase by 50%.income would increase by 50%.
P
t i
i^
l^
P
ercent increase in sales
Degree of operating leverage
×^
Percent increase in profits
Here’s the verification!
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