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# Chapter 5 Cost-Volume-Profit Relationships Part 1

Cost-volume-profit (CVP) analysis helps managers make many important decisions such as:
- what products and services to offer
- what prices to charge
- what marketing strategy to use
- what cost structure to maintain

## Profits are affected by 5 factors:

1. Selling prices
2. Sales volume
3. Unit variable costs
4. Total fixed costs
5. Mix of products sold

## *assumptions for these 5 factors:

- Selling price is constant. Price of a product or service will not change as volume changes
- Costs are linear and can be accurately divided into Variable and Fixed. Variable per unit is fixed and
total Fixed cost is constant within the relevant range.
- In multi-product companies, the mix of products sold remains constant.

Contribution Margin amount remaining from sales revenue after variable expenses have been
deducted

## Break-even point level of sales at which profit is zero

*once break-even point is reached, net operating income will increase by the amount of the unit
contribution margin of each additional unit sold

## CVP in equation form:

Contribution format income statement expressed in equation:

## Profit = (Sales Variable expenses) Fixed expenses

OR
Profit =(P x Q V X Q) Fixed expenses
CVP in graphic form:

## CM Ratio = Contribution Margin

Sales

CM ratio shows how the contribution margin will be affected by a change in total sales.
- For example: a 40% CM means that for each dollar increase in sales, total contribution margin will
increase by \$0.40.

## Change in Profit = CM ratio X Change in sales change in fixed expenses

Application of CVP

## Change in Fixed Cost and Sales Volume:

Textbook example: Acoustic Concepts
- Currently selling 400 speakers per month at \$250 per speaker
- Current Fixed expenses of \$35,000
- Current Variable Costs of \$150 per speaker

## 2 shorter ways to arrive at same solution:

Incremental analysis considering only the costs and revenues that will change if the new program is
implemented. Alternative solutions 1 and 2 above use this type of analysis.
Change in Variable Costs and Sales Volume:
- Variable costs increase \$10/speaker
- Sales increase from 400 to 480 speakers

*if Variable costs increase by \$10, then unit contribution margin would go down \$10, from \$100 to
90/speaker.

## Change in Fixed Cost, Selling Price, and Sales Volume:

- Cut selling price from \$250 to \$20 lower
- Increase advertising budget by \$15,000/month
- Sales to increase 50% to 600 speakers per month

*decrease in selling price per speaker will reduce the Contribution Margin by \$20, down to \$80

## Change in Variable Cost, Fixed Cost, and Sales Volume:

- Change cost for sales commission of \$15 per speaker sold, rather than the flat salaries now that
total \$6,000 per month
- Sales will increase monthly by 15% to 460 speakers per month

## Change in Selling Price:

- Opportunity for special bulk sale of 150 speakers.
- No change on regular sales or fixed costs
- What price per speaker would be quoted to the wholesaler if a profit of \$3,000 is desired?

*fixed expenses are not included in the calculations because fixed expenses are not affected by the bulk
sale. All additional contribution margin increases the companys profits.