Chapter 7 Cost-Volume-Profit Relationships.docx

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University of Waterloo
Accounting & Financial Management
AFM 102
Tom Vance

07– Cost-Volume-ProfitRelationships Chapter 7: Cost-Volume-Profit Relationships  CVP analysis is a powerful tool that helps managers understand the relationships among cost, volume, and profit  focuses on: prices of products, volume/level of activity, per unit variable cost, TFC and mix of products sold The Basicsof Cost-Volume-Profit (CVP)Analysis Contribution Margin  the amount remaining from sales revenue after variable expense have be deducted  break-even point: the level of sales at which profit is zero  total sales equals total expenses  total contribution margin equals total fixed expenses  sales – variable expenses – fixed expenses = 0  once the break-even point has been reached, operating income will increase by the unit contribution margin for each additional unit sold  if sales are zero, the company’s loss would equal the fixed costs CVP Relationships in Graphic Form  cost-volume-profit graph: the relationships among revenues, costs and level of activity in an organization presented in graphic form Preparing the CVP Graph  sometimes called the break-even chart  unit volume on the x-axis and $ on the y-axis  total fixed cost is a horizontal line  total variable cost has slope equal to per unit variable cost and crosses the origin  total costs cuts the y-axis with the total fixed cost and has the same slope has total variable cost  total revenue has slope equal to price per unit and crosses the origin  break-even point is where the total revenue and total expenses cross  profit is the area above the break-even point (between total rev. and total exp) and loss is the area below ContributionMargin(CM) Ratio  contribution (CM) ratio: the contribution margin as a percentage of total sales contributionmargin  CMratio sales Break-Even Analysis Break-Even Computations X = break-even point in units sold  equation method: a method of computing break-even sales using the contribution format income statement profit = (sales – variable expenses) – fixed expenses sales = variable expenses + fixed expenses + profits $salesX = $varX + $fix + 0 X = ($fix)/($sales - $var)  variable expense ratio: the ratio of var. exp. to sales dollars [var.exp/sales] page 1 of 3 07– Cost-Volume-ProfitRelationships  contribution margin method: a method of computing the break-even point in which fixed expenses are divided by the contribution margin per unit X = fixed exp/unit contribution margin Target Operating Profit Analysis  CVP Equation: X = (var exp + fixed exp + target profit) / (sales per unit – var per unit)  contribution margin approach: X = (fixed exp + target profit) / unit contribution margin After-TaxAnalysis income after tax = before-tax profit – taxes = B – t(B) = B(1 – t) B = income after tax / (1 – t) The Marginof Safety  margin of safety: the excess of budgeted (or actual) sales over the break-even volume of sales  margin of safety = total budgeted (or actual) sales –
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