TARGET NET PROFIT

Managers can also

use CVP analysis
to determine the
total sales, in units
and dollars,
needed to reach a
target net profit.
 TARGET NET PROFIT

➣Contribution Margin Technique

Target sales volume in units =

Fixed expenses + Target net income

Contribution margin per unit
 TARGET NET PROFIT

➣Equation Technique

Target sales
- Variable expenses
- Fixed expenses
= Target net income
 INCREMENTAL APPROACH TO
TARGET NET PROFIT

➣The incremental effect is

the change in total results
(such as revenue, expenses, or
income) under a new condition
in comparison with some given
or known condition.
 OPERATING LEVERAGE

➣The ratio of fixed to variable

costs is called operating
leverage.
 OPERATING LEVERAGE

In highly leveraged companies

-- those with high fixed costs
and low variable costs --
small changes in sales
volume result in large
changes in net income.
 OPERATING LEVERAGE

Companies with less

leverage (that is, lower
fixed costs and higher
variable costs) are not
affected as much by
changes in sales volume.
 VARIABLE-COST RATIO

➣The variable-cost ratio or

variable-cost percentage is
defined as all variable costs
divided by sales.
Thus a contribution-margin ratio of
20% means that the variable-
cost ratio is 80%.
 CONTRIBUTION MARGIN AND
GROSS MARGIN

Too often people confuse the

terms contribution margin
and gross margin.
 CONTRIBUTION MARGIN AND
GROSS MARGIN

➣Gross margin (which is also called

gross profit) is the excess of sales
over the cost of goods sold.

➣Cost of goods sold is the cost of the

merchandise that is acquired or
manufactured and resold.
 CONTRIBUTION MARGIN AND
GROSS MARGIN

Compare the gross margin with the

contribution margin:
gross margin=
sales price-cost of goods sold

contribution margin=
sales price-all variable expenses
 CONTRIBUTION MARGIN AND
GROSS MARGIN

Contribution margin focuses

on sales in relation to all
variable costs whereas gross
margin focuses on sales in
relation to cost of goods sold.
 Exercises

2-26
2-27
2-28