Slides identify sensitive variables

Identify Sensitive Variables Principles of Cost Analysis and Management © Dale R Geiger 2011 We assume cross traffic will stop What if our assumption is incorrect? © Dale R Geiger 2011 Terminal Learning Objective • Action: Identify Sensitive Variables Through What-if Scenarios • Condition:  You are a cost advisor technician with access to all regulations/course handouts, and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors • Standard: With 80% accuracy: Define “sensitive variable” Calculate new breakeven point given changes in assumptions Calculate breakeven selling price for a given sales quantity Solve for missing variables in the breakeven equation given changed assumptions © Dale R Geiger 2011 Review: Key Variables and Assumptions: • The Breakeven Equation: Revenue - Variable Cost - Fixed Cost = Profit • What are the key variables? Revenue = #Units Sold * Selling Price $/Unit Variable Cost = #Units Sold * Variable Cost $/Unit • Assumes… ONLY ONE product or service is sold © Dale R Geiger 2011 Review: Key Variables and Assumptions: • The Breakeven Equation: Revenue - Variable Cost - Fixed Cost = Profit • What are the key variables? Revenue = #Units Sold * Selling Price $/Unit Variable Cost = #Units Sold * Variable Cost $/Unit • Assumes… ONLY ONE product or service is sold © Dale R Geiger 2011 Review: Key Variables and Assumptions: • The Breakeven Equation: Revenue - Variable Cost - Fixed Cost = Profit • What are the key variables? Revenue = #Units Sold * Selling Price $/Unit Variable Cost = #Units Sold * Variable Cost $/Unit • Assumes… ONLY ONE product or service is sold © Dale R Geiger 2011 Review: Key Variables and Assumptions: • The Breakeven Equation: Revenue - Variable Cost - Fixed Cost = Profit • What are the key variables? Revenue = #Units Sold * Selling Price $/Unit Variable Cost = #Units Sold * Variable Cost $/Unit • Assumes ONLY ONE product or service is sold © Dale R Geiger 2011 Importance of Assumptions • Making assumptions is inescapable in managerial costing • There is simply too much to measure and too many ways to measure it • Reasonable assumptions simplify and facilitate the measurement process • Bad assumptions result in poor management decision making © Dale R Geiger 2011 Check on Learning • What are two key assumptions in Breakeven Analysis? Why are assumptions important? â Dale R Geiger 2011 What is Sensitivity Analysis? • Recognizes that the validity of the decision depends on the validity of the underlying assumptions • Requires the Decision Maker to identify assumptions • Tests the validity of assumptions through What-If scenarios © Dale R Geiger 2011 10 Check on Learning • When using the Sensitivity Analysis Spreadsheet, what is the first question we should ask? • Once we have found the solution to the unknown variable, what questions should we ask? © Dale R Geiger 2011 52 Sales Mix Issues • Remember our key assumptions! • What if an entity sells more than one product? • Breakeven analysis is based on the Sales Mix • What percentage of the Total Sales in units does each product comprise? © Dale R Geiger 2011 53 Sales Mix Example • Sebastian’s Dinner Theater offers a Senior Discount in addition to regular price • Senior price is $20 per ticket • Seniors receive a reduced food portion • Variable cost = $7 per ticket • Sales Mix is 30% Senior and 70% Regular • Regular price is $30 and Variable Cost is $10/ticket • Fixed costs = $2000 • Task: Calculate the breakeven number of tickets â Dale R Geiger 2011 54 Sales Mix Calculate Weighted Average $Price/Ticket: percentage1 * price1 + percentage2 * price2 30%*$20 + 70%*$30 = $6 + $21 = $27 percentage1 and price1 represent Senior tickets percentage2 and price2 represent Regular tickets © Dale R Geiger 2011 55 Sales Mix • Calculate Weighted Average $VC/Ticket: percentage1 * VC1 + percentage2 * VC2 30%*$7 + 70%*$10 = $2.10 + $7 = $9.10 percentage1 and VC1 represent Senior tickets percentage2 and VC2 represent Regular tickets © Dale R Geiger 2011 56 Sales Mix • What is the weighted average Contribution Margin per unit? $CM/Ticket = $Price/Ticket - $VC/Ticket $27/Ticket - $9.10/Ticket = $17.90/Ticket • For each Ticket sold, profit will increase by an average of $17.90 © Dale R Geiger 2011 57 Sales Mix • Use the Sales Mix tab on the 9.2 Sensitivity Analysis spreadsheet to calculate: • • • • Weighted average price Weighted average variable cost per unit Weighted Average contribution margin Breakeven point © Dale R Geiger 2011 58 Sensitivity Analysis Spreadsheet Enter the percentage for each product The spreadsheet will verify that the total equals 100% © Dale R Geiger 2011 59 Sensitivity Analysis Spreadsheet Enter price per unit and variable cost per unit for each product The spreadsheet calculates CM per unit for each product, and weighted average selling price, variable cost, and contribution margin © Dale R Geiger 2011 60 Sensitivity Analysis Spreadsheet Enter the Fixed Cost The spreadsheet calculates the quantity of each type of product and the total number of units that must be sold to breakeven © Dale R Geiger 2011 61 Breakeven Theory If: Contribution Margin = Revenue – Variable Cost And the breakeven equation is: Revenue – Variable Cost – Fixed Cost = Or Contribution Margin – Fixed Cost = Then breakeven occurs when: Contribution Margin = Fixed Cost © Dale R Geiger 2011 62 Graphic Illustration © Dale R Geiger 2011 63 What if? • How would the breakeven point change if the actual sales mix was 40% Senior and 60% Regular? 50/50? • What else might Sebastian’s management consider in this decision? © Dale R Geiger 2011 64 Check on Learning • What is the first step when calculating breakeven for an entity that sells more than one product? © Dale R Geiger 2011 65 Practical Exercises © Dale R Geiger 2011 66 ... our assumption is incorrect? © Dale R Geiger 2011 Terminal Learning Objective • Action: Identify Sensitive Variables Through What-if Scenarios • Condition:  You are a cost advisor technician with... changes in assumptions and estimates represent sensitive variables © Dale R Geiger 2011 11 Check on Learning • How we test our assumptions? What is a sensitive variable? â Dale R Geiger 2011 12... all variables are known except Number of Units • What if one of the other variables is the unknown? © Dale R Geiger 2011 16 Sensitivity and Breakeven • The breakeven equation includes five variables: