### Cost Volume Profit Analysis

## Things You Must Know

### Introduction to Accounting

** Contribution Margin –**

Sales revenue less all variable costs

It is the amount available to cover fixed costs and give profit

Sales

__Less ALL Variable Costs__

**Contribution Margin**

__Less ALL Fixed Costs__

Net Operating Income/Loss

Sales, variable costs, and contribution margin are expressed on a per unit basis because as volume changes the total $ changes.

**Contribution margin per unit** = Sales price per unit – **all** variable costs per unit

**Contribution Margin Ratio ** = __Contribution Margin__ in total or per unit

Sales

The percent of every sales dollar that is available for profit once fixed costs are covered.

Change in Sales $

__x Contribution Margin Ratio__

= Change in Contribution Margin $

**Break Even: **Occurs when profit = 0, which occurs when contribution margin is equal to fixed costs

*Break Even for Unit Sold:*

__ Fixed Costs______________Contribution Margin Per Unit

*Break Even for Sales $*

__ Fixed Costs_______________Contribution Margin Ratio (%)

**Add the desired profit to the formula to determine required to earn a before tax profit**.

*Sell ? units to earn a profit:*

__Fixed Costs + Profit__Contribution Margin Per Unit

*Sales $ of ? to achieve a certain profit:*

__Fixed Costs + Profit__Contribution Margin Ratio (%)

The profit should always be stated in before tax dollars. To convert after tax dollars to before tax dollars use this formula: After tax profit / (1 – tax rate %)

**Margin of Safety** = Total Budgeted or Current Sales – Break Even Sales

**Margin of Safety %** = Margin of Safety / Total Budgeted or Current

**Operating Leverage:** Used to estimate how much profits will change when sales dollars change??

= __Contribution Margin__ = A factor

Net Operating Income

Take the factor times the % increase in sales to determine the % increase in profits that should occur

To get the expected income in dollars use this formula:

Operating Leverage Factor

__x % increase in sales__

= % increase in profits

__x current profits__

= added profits

__+ current profits__

= expected profits if sales increase by that %

**Sales Mix:** The percentage of total sales for each product.

This is important when a company has more than one product.

A change in sales mix can change the total profit.

Different products have a different contribution margin.

Lower sales in products with high contribution margins can reduce total company profits.

Higher sales in products with lower contribution margins can reduce total company profits.

**When a company has more than one product CVP analysis is done in the following ways:**

1. Using a total company average for the CM ratio:

__Total Contribution Margin for the Company__ = Total CM %

Total Sales for the Company

2. Use the weighted average (W.A.) method:

Compute a weighted average sales price per unit

Compute a weighted average contribution margin per unit

Then W. A. CM per unit / W.A. Sales per unit = W. A. CM %

**Determine if the company should increase fixed costs**

Incremental Contribution Margin

__less Increase in Fixed Expenses__

= Change in Income from the Decision

To get the incremental contribution margin:

Expected Sales$ x % CM Ratio = Expected Contribution Margin

__Less Current Sales $ x % CM Ratio = Current Contribution Margin__

= Incremental Contribution Margin

OR

Expected Sales in units X CM per unit = Total Expected CM

__less Current Sales in units X CM per unit = Current CM __

= Incremental CM

**Cost Volume Profit Graph:**

Put sales $ on the vertical axis and units on the horizontal axis

1) Draw a horizontal line for fixed expenses

2) Chose a volume of sales and put a dot for sales and total expenses

3) Draw a line from the sales dollar plot to the corner (0,0)

4) Draw a line from the total expense plot from the fixed expense line on the vertical axis

Where the two lines cross is the break – even point

The cost volume profit graph is not taught in most managerial accounting classes and the discussion here is very limited. Please see your class notes to determine if you need to know more on this topic.