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Chapter 5

BUS 215 Chapter 5: Cost-Volume-Profit Relationships

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BUS 215
Trisha Anderson

• Cost-volume-profit (CVP) analysis helps managers make many important decisions such as what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to maintain. Its primary purpose is to estimate how profits are affected by the following five factors: 1. Selling prices. 2. Sales volume. 3. Unit variable costs. 4. Total fixed costs. 5. Mix of products sold. • To simplify CVP calculations, managers typically adopt the following assumptions with respect to these factors : 1. Selling price is constant. The price of a product or service will not change as volume changes. 2. Costs are linear and can be accurately divided into variable and fixed elements. The variable element is constant per unit. The fixed element is constant in total over the entire relevant range. 3. In multiproduct companies, the mix of products sold remains constant. • Break Even Point: Once the break-even point has been reached, net operating income will increase by the amount of the unit contribution margin for each additional unit sold • CVP Relationships in Equation Form o Profit = (Sales - Variable expenses) - Fixed Expenses o Sales = Selling Price per unit * Quantity sold = P * Q o Variable expenses = Variable expenses per unit * Quantity Sold = V * Q o Profit = (P * Q - V * Q) - Fixed Expenses o Profit = Unit CM * Q - Fixed Expenses CVP Relationships in Graphic Form • o The relationships among revenue, cost, profit, and volume are illustrated on a cost- volume- profit (CVP) graph . • Contribution Margin Ratio (CM Ratio) o The contribution margin as a percentage of sales is referred to as the contribution margin ratio (CM ratio) o CM ratio = contribution margin divided by sales o Change in Contribution Margin = CM ratio * Changes in sales • the impact on net operating income of any given dollar change in total sales can be
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