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BUS 215
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Trisha Anderson
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Chapter 5

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Business

BUS 215

Trisha Anderson

Spring

Description

• 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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