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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:

Contribution margin ratio contribution margin as a percentage of sales

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.

Other ways to express CM:

Profit = CM ratio X Sales Fixed Expenses

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.