ACC 2203 Lecture Notes - Lecture 5: Income Statement, Contribution Margin, Earnings Before Interest And Taxes
2 Jun 2018
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CHAPTER 5 – COST VOLUME PROFIT ANALYSIS
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© COPYRIGHTED 2014. Y. PAN. ALL MATERIALS ARE COPYRIGHTED AND MAY NOT BE DUPLICATED, DISTRIBUTED,
COST VOLUME PROFIT ANALYSIS
Why is profit important? The goal of many businesses is to make profits. Profits are crucial to the growth and expansion of a business.
Without profits, a business is not likely to continue its operations in the long run.
1. A company must be able to make profit to succeed and stay in business long term
2. A company must be able to BREAKEVEN at the very least
3. If a company cannot breakeven, they must make decisions to MINIMIZE their losses
TOTAL REVENUE/SALES (TR or TS) – (revenue and sales are interchangeable for the purposes of this chapter) the total amount
of money you will receive from the number of units sold ($ amount)
TOTAL VARIABLE COSTS/EXPENSES (TVC or TVE) – (costs and expenses are interchangeable for the purposes of this
chapter) the total amount of money you will spend based on number of units sold ($ amount)
TOTAL FIXED COSTS/EXPENSES (TFC or TFE) – the total amount of money you will spend REGARDLESS of the number of
units sold
Contribution Format:
(TS) +Total Sales Net Income = TS – TVE – TFE TS – TVE = CM
(TVE) -Total Variable Expenses Net Income = (pq) – (vq) – TFE sales = unit price x # of units sold; pq
(CM) =Contribution Margin OR Net Income = (p-v)(q) - TFE
(TFE) -Total Fixed Expenses OR (less common)
(NI) =Net Income Net Income = (unit cm)(q) – TFE
*remember price and cost are two different things, p: unit selling price; how much is 1 unit selling for?
price is how much you sell something for, and v: unit variable cost; how much does it cost to acquire/make 1 unit?
cost is how much it cost you to acquire/make it q: quantity; how many units sold?
unit cm: unit contribution margin; the cm for 1 unit (p-v)
Reminder: Variable expenses depend on the number of units sold (i.e. commissions) while fixed expenses do not (i.e. base salary).
CHAPTER 5 – COST VOLUME PROFIT ANALYSIS
!
_________________________________________________________________________________________________________________________________
© COPYRIGHTED 2014. Y. PAN. ALL MATERIALS ARE COPYRIGHTED AND MAY NOT BE DUPLICATED, DISTRIBUTED,
BREAKEVEN
Breakeven is the point where the amount of SALES (in dollars $) or QUANTITY (# of units sold) nets 0 income or loss. To
find the breakeven point, always set net income = 0
AT BREAKEVEN, NET INCOME = 0. A company should always strive to breakeven at the very least, minimize losses, and
maximize profits
0 = (p – v)(q) – TFE *breakeven sales and breakeven units sold are two different things
breakeven quantity (q) X selling price à BREAKEVEN SALES ( total $ amount) = sales needed to breakeven
Breakeven q = TFE / (p – v) à BREAKEVEN QUANTITY (unit amount) = number of units sold to breakeven
TARGIT PROFIT
The amount of sales (in $) you need to generate or the # of units you need to sell in order to achieve your desired profit.
If target profit is $100, set net income equal to $100 à $100 = (p – v)(q) – TFE
CONTRIBUTION MARGIN RATIO (CMR) – How much of sales is contribution margin? How much additional profit will
contribute to net income (“bottom line”) if there is an increase in sales?
If your sales are $100 and your contribution margin ratio is 20%, then if sales increase by $50, net income will increase by $10
($50 X .20 = $10). Since fixed expenses will not change regardless of the # of units you sell, additional CM will increase net income.
CM RATIO = (p – v) / p
Or
CM RATIO = (total contribution margin) / (total sales)
Net Income = (p – v) (q) – TFE
= [((p – v) / p) X (sales)] - TFE
= [((p – v ) / p) X (pq)] – TFE
CHAPTER 5 – COST VOLUME PROFIT ANALYSIS
!
_________________________________________________________________________________________________________________________________
© COPYRIGHTED 2014. Y. PAN. ALL MATERIALS ARE COPYRIGHTED AND MAY NOT BE DUPLICATED, DISTRIBUTED,
MARGIN OF SAFETY
Margin of Safety is the amount of sales ($) after breakeven. This is important because the goal of a company at the very least is
to breakeven. Sales made after breakeven are the sales contributing to profit.
Margin of Safety = Total Sales – Breakeven Sales
MOS = TS – BS
Margin of Safety in % = Margin of Safety (in $) / Total Sales (in $)
*Margin of Safety can also be in # of units
Margin of Safety in units X selling price = Margin of Safety in dollars ($)
