Topic 3

Cost-Volume-Profit Relationships Topic 03 5-2 • What is the implication of Contribution margin per unit? • What is the implication of Contribution margin ratio? 5-3 Break-even point Break-even point in units sold Break-even point in total sales dollars Fixed expenses Unit contribution margin = = Fixed expenses CM ratio 5-4 CVP Graph $ Sales Total costs Fixed costs units 5-5 Incremental analysis Racing Bicycle is currently selling 500 bikes per month The company’s sales manager believes that an increase of $10,000 in the monthly advertising budget would increase bike sales to 540 units  Should we authorize the requested increase in the advertising budget? 5-6 Incremental analysis $80,000 $80,000++$10,000 $10,000advertising advertising==$90,000 $90,000 Sales Salesincreased increasedby by$20,000, $20,000, but butOperating Operatingincome income decreased decreasedby by$2,000 $2,000 5-7 Incremental analysis The Shortcut Solution 5-8 Target Profit Analysis Suppose Racing Bicycle wants to know how many bikes must be sold to earn a profit of $100,000 5-9 The Margin of Safety Excess of budgeted (or actual) sales over the break-even volume of sales The amount by which sales can drop before losses begin to be incurred Margin of safety = Total sales - Break-even sales 5-10 Operating Leverage • A measure of how sensitive operating income is to percentage changes in sales • With high leverage, a small percentage increase in sales can produce a much larger percentage increase in operating income Degree of operating = leverage (DOL) Degree of operating leverage ∆% Operating income ∆% Sales = Contribution margin Operating income 5-11 The Concept of Sales Mix • Sales mix is the relative proportions in which a company’s products are sold ▫In units ▫In dollars • Average contribution margin per unit = ∑ UCMi X unit sales mixi • Average contribution margin rate = ∑ CM ratioi X $ sales mixi 5-12 End of Topic 03 ... unit sales mixi • Average contribution margin rate = ∑ CM ratioi X $ sales mixi 5-12 End of Topic 03 ... implication of Contribution margin per unit? • What is the implication of Contribution margin ratio? 5 -3 Break-even point Break-even point in units sold Break-even point in total sales dollars Fixed