ADMN 3021H Chapter 4: Chapter 4

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Trent University
Business Administration
ADMN 3021H
Malcolm Mac Taggart

Chapter 4 – Cost-Volume-Profit Relationships CVP Relationship Interactions • CVP analysis is a powerful tool that managers use to help them understand the interrelationship among cost, volume and profit in an organization by focusing on interactions among the following five elements: o Prices of products o Volume or level of activity o Per unit variable costs o Total fixed costs o Mix of products sold Basics • The contribution income statement is helpful to managers in judging the impact on profits of changes in selling price, cost, or volume o Emphasis is on cost behaviour • Contribution Margin (CM) = Sales Revenue – Variable Expenses • CM Ratio = Total Contribution Margin/Total Sales • Break-even Point – when profits equal zero • The relationship among revenue, cost, profit and volume can be expressed graphically by preparing a CVP graph o Unit volume on X-axis o Dollars on Y-axis o Fixed expenses, total expenses, and total sales lines CM Ratio = Unit CM/ Unit Selling Price Profit = Unit CM x Q – Fixed Expenses CM = Sales – Variable Expenses CM Per Unit = Per unit sales – Per unit Variable Expenses Variable Expense Ratio = Variable expenses/Sales Break-Even Analysis • Can be approached in two ways: equation method and formula method • Equation Method o Profits = (Sales – Variable expenses) – Fixed expenses o Sales = Variable expenses + Fixed expenses + Profits ▪ At the break-even point, profits equal zero • Formula Method o Break-even point in units sold = Fixed expenses/CM per unit o Break-even point in total sales dollars = Fixed expenses/CM ratio Target Profit Analysis • The equation and formula methods can be used to determine the sales volume needed to achieve a target profit The Margin of Safety • The excess of budgeted (or actual) sales over the break-even volume of sales • Margin of safety = Total sales – Break-even sales • Can be expressed in terms of the number of units sold • Margin of safety percentage = Margin of safety in Dollars/Total Sal
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