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Accounting & Financial Management
AFM 481
Grant Russell

CHAPTER 3: COST VOLUME PROFIT ANALYSIS Cost-Volume-Profit Analysis - To examine changes in profits in response to changes in sales volumes, cost and prices Profit Equation and Contribution Margin - Contribution margin = total revenue – total variable cost - Contribution margin (CM ) = selling price per unit – variable cost per unit u - Earnings before tax (EBT) = (selling price – variable cost) × quantity – fixed costs CVP Analysis in Units - Assume that fixed costs, selling price and variable costs are constant - We can use the formula to solve for Q - This will give us quantity required to achieve our target profit (EBT) - Q = (fixed costs + EBT) / CM u CVP Analysis in Revenues - Contribution margin ratio (CMR) is the % of the selling price per unit over the variable cost per unit - CMR = (S – V) / S for a single unit - Selling price × Q (revenue) = (fixed costs + EBT) / CMR Performing CVP Analysis Breakeven Point - Level of operating activity so that sales revenue = 0 - We went to set EBT = 0 - Breakeven quantity is the Q that will make EBT = 0 - Breakeven revenue is the amount of revenue at Q which makes EBT = 0 (revenue = expense) Cost-Volume-Profit Graph - Relationship between total revenue and total cost - Where total revenue = total cost, the is the Q that will result in breakeven, at the breakeven revenue CVP with Income Taxes - After-tax earnings are calculated by subtracting tax from pretax earnings - EAT = EBT × (1 – tax rate) CVP with Variable Amount of Earning - Want to express earnings as a % of sales (i.e. EBT of 7.5% of sales) - Recall: EBT = Q × ( S – V) – F = % of S; solve for S = total sales - Can incorporate taxes into the formula; take the after-tax % of sales to calculate the pretax % Performing CVP Analysis with a Spreadsheet CVP Calculations for a Sales Mix - Sales mix is the proportion of diff products/services that the firm sells - Assume a constant sales mix (i.e. constant ratio between products) CVP Calculations for a Sales Mix - Stated as a portion of units for CVP in units; stated as a proportion of revenues for CVP revenues - Need to calculate CM u(composite)eighted average of the CM for each product) - Sales revenue = Fixed costs / CM = thu amount of composite units to breakeven (Q composite CVP Sensitivity Analysis - Benefit of using a spreadsheet with an input section – data can be changed easily to analyze various results - Determine the effect of changing the sales mix - Can easily change the desired after-tax earning (change to zero to determine breakevens) - Every assumption can be changed easily Discretionary Expenditure Decisions - Use manager’s decision or estimates in the spreadsheet to analyze various results - i.e. what would happen in fixed costs increased, etc. Planning, Monitoring, and Motivating with CVP - Useful to plan and monitor operations - Useful for motivating employee performance - Identify differences between revenue levels and cost functions Assumptions and Limitations of Cost-Volume-Profit Analysis - Input data
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