Session 8

Cost-Volume-Profit Analysis
Manageria
l
Accountin
g
Ng Eng Wan
FCPA CIA ACMA CGMA

1
 •
8.1 Calculate the unit contribution
margin and the contribution margin
ratio
•
8.2 Use CVP analysis to find
breakeven points and target profit
Learning volumes

Objectives 8.3 Use CVP analysis to measure the

•

impact of changing business conditions

•
8.4 Find breakeven and target profit
volumes for multiproduct companies
•
8.5 Determine a firm’s margin of safety,
operating leverage

2
 Learning
Objective 1
Calculate the unit contribution margin and
the contribution margin ratio

3
 • Expresses relationship among
costs, volume, and the
Cost- company’s profit
Volume- • Powerful tool that helps
managers make business
Profit decisions
Analysis • Determine sales volume needed
to break even or earn a target
profit

Profit = (Sales – Variable expenses) – Fixed expenses

Sales = Price * Volume

Components of CVP Analysis

5
 1. Sales price remains constant
throughout the relevant range of
volume.
2. Managers can classify each cost as
either variable or fixed.
3. Fixed costs remain ‘fixed’ over the time
CVP period and/or a given range of activity
(often referred to as the relevant
Assumption range)
s 4. Variable cost per unit remain constant
over the time period and relevant
range
5. The product mix offered for sale
remains constant.

6
 • Contribution margin: Sales
revenue - variable expenses.
• Unit contribution margin (or CM
The Unit per unit): Selling price per unit -
Contribution variable cost per unit.
Margin • All variable costs (product and
period) must be included when
calculating the unit contribution
margin.

7
 Kay has an online poster business.
Unit She currently sells each poster for
$35, while each poster has a
Contribution variable cost of $21. Kay has
Margin monthly fixed costs of $7,000. Her
Example— relevant range is 0 to 2,000 and
Kay’s she is currently selling 550
Posters (1 of posters.
3)

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Unit Contribution Margin Example—Kay’s Posters
(2 of 3)

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Unit Contribution Margin
Example—Kay’s Posters (3 of 3)

Sales price per unit $35

Less: Variable cost per unit (21)
Unit contribution margin $14

• Kay earns $14 every time she sells a poster that can
be used to:
• Pay fixed expenses
• Earn a profit

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 • Unit contribution margin ÷ Sales price per unit
• Contribution margin ÷ Sales revenue
• Kay’s calculations:

$14 / $35 = 40%

$7,700 / $19,250 = 40%

Contribution
Margin Ratio

11
The Contribution Approach
Sales, variable expenses, and contribution margin
can also be expressed on a per unit basis. If Racing
sells an additional bicycle, $200 additional CM will
be generated to cover fixed expenses and profit.
 The Contribution Approach
Each month, RBC must generate at least
$80,000 in total contribution margin to break-even
(which is the level of sales at which profit is zero).
The Contribution Approach
If RBC sells 400 units in a month, it will be
operating at the break-even point.
The Contribution Approach
If RBC sells one more bike (401 bikes), net
operating income will increase by $200.
 The Contribution Approach
We do not need to prepare an income statement to
estimate profits at a particular sales volume. Simply
multiply the number of units sold above break-even
by the contribution margin per unit.
If Racing sells
430 bikes, its net
operating income
will be $6,000
($30*$200).

16
CVP Relationships in Equation
Form
The contribution format income statement can be
expressed in the following equation:

Profit = (Sales – Variable expenses) – Fixed expenses

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CVP Relationships in Equation
Form
This equation can be used to show the profit RBC
earns if it sells 401. Notice, the answer of $200 mirrors
our earlier solution.
Profit = (Sales – Variable expenses) – Fixed expenses

$80,000
401 units × $500
401 units × $300

Profit
$200 = ($200,500 – $120,300)
Variable expenses)
– $80,000
Fixed expenses
– Fixed

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 CVP Relationships in Equation
Form
When a company has only one product we can further
refine this equation as shown on this slide.

Profit = (Sales – Variable expenses) – Fixed expenses

Profit = (P × Q – V × Q) – Fixed expenses

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 CVP Relationships in Equation
Form
This equation can also be used to show the $200
profit RBC earns if it sells 401 bikes.
Profit = (Sales – Variable expenses) – Fixed expenses

Profit = (P × Q – V × Q) – Fixed expenses

$200 = ($500 × 401 – $300 × 401) – $80,000

Profit

20
 CVP Relationships in Equation
Form
It is often useful to express the simple profit equation in
terms of the unit contribution margin (Unit CM) as follows:

Unit CM = Selling price per unit – Variable expenses per unit

Unit CM = P – V
Profit = (P × Q – V × Q) – Fixed expenses
Profit = (P – V) × Q – Fixed expenses
Profit = Unit CM × Q – Fixed expenses

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 CVP Relationships in Equation
Form
Profit = (P × Q – V × Q) – Fixed expenses
Profit = (P – V) × Q – Fixed expenses
Profit = Unit CM × Q – Fixed expenses
Profit = ($500 – $300) × 401 – $80,000
Profit = $200 × 401 – $80,000
This equation
Profit = $80,200 – $80,000 can also be
Profit = $200 used to
compute RBC’s
$200 profit if it
sells 401 bikes.
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 Learning
Objective 2
Use CVP analysis to find breakeven points
and target profit volumes

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 • The sales level at which
operating income is zero
• Total revenues = Total expenses
• Sales below breakeven point 
Breakeve loss
• Sales above breakeven point 
n Point profit
• Two ways to calculate (unit sales
& dollar sales)
• The equation method
• The formula method

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Break-even in Unit Sales:
Equation Method
Profits = Unit CM × Q – Fixed expenses
Suppose RBC wants to know how many
bikes must be sold to break-even
(earn zero profit).

$0 = $200 × Q + $80,000

Profits are zero at the break-even point.

25
Break-even Profits = Unit CM × Q – Fixed
in Unit Sales:
expenses
Equation
Method

$0 = $200 × Q + $80,000

$200 × Q = $80,000

Q = 400 bikes

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Break-even in Unit Sales:
Formula Method
Let’s apply the formula method to solve for
the break-even point.
Unit sales to Fixed expenses
=
break even CM per unit

$80,000
Unit sales =
$200
Unit sales = 400
 Break-even in Dollar Sales:
Equation Method
Suppose Racing Bicycle wants to compute
the sales dollars required to break-even (zero
profit). Let’s use the equation method to solve
this problem.

Profit = CM ratio × Sales – Fixed expenses

Solve for the unknown “Sales.”

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 Break-even in Dollar Sales:
Equation Method
Profit = CM ratio × Sales – Fixed expenses
$ 0 = 40% × Sales – $80,000

40% × Sales = $80,000

Sales = $80,000 ÷ 40%

Sales = $200,000

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Break-even in Dollar Sales:
Formula Method
Now, let’s use the formula method to calculate the
dollar sales at the break-even point.

Dollar sales to Fixed expenses

=
break even CM ratio

$80,000
Dollar sales =
40%
Dollar sales = $200,000

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Target Profit—Unit Contribution
Margin
How many posters does Kay need to sell to earn
$4,900 profit?

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Target Profit—Contribution
Margin Ratio
How much sales revenue does Kay need to
generate to earn $4,900 profit?

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 • Step 1: Choose a sales volume. Plot
the point for total sales revenue at
that volume. Draw the sales revenue
line from the origin through the point.
• Step 2: Draw the fixed expense line; a
horizontal line that intersects the y-
Graphing axis.
CVP • Step 3: Draw the total expense line.
Relationships Sum of variable plus fixed expenses.
• Step 4: Identify the breakeven point.
Where sales revenue intersects total
expense.
• Step 5: Mark the operating income
and operating loss areas.

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CVP Graph

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 Learning
Objective 3
Use CVP analysis to measure the impact of
changing business conditions

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 • Prepare for increasing costs,
pricing pressures, and other
changing business conditions
• “What-if” technique
Sensitivit • What if sales price changes?
y Analysis • What if costs change?
• What is the sales mix changes?
• Use CVP to conduct sensitivity
analysis

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 • Breakeven point changes
Changing the • Unit contribution margin
Sales Price changes
and Volume
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 • Breakeven point changes
Changing • Unit contribution margin changes
• Higher variable costs have the same
Variable effect as lower selling prices—reduce
unit contribution margin
Costs
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 • Changes breakeven point
Changing • Does NOT change unit
contribution margin
Fixed Costs
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The Variable Expense Ratio
The variable expense ratio is the ratio of variable
expenses to sales. It can be computed by dividing the total
variable expenses by the total sales, or in a single product
analysis, it can be computed by dividing the variable
expenses per unit by the unit selling price.

40
 What is the profit impact if
Changes in Racing Bicycle can increase
Fixed Costs unit sales from 500 to 540 by
increasing the monthly
and Sales advertising budget by $10,000?
Volume
Changes in Fixed Costs and
Sales Volume
$80,000 + $10,000 advertising = $90,000

Sales increased by $20,000, but net operating income

decreased by $2,000.
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Changes in Fixed Costs and
Sales Volume
A shortcut solution using incremental
analysis
 What is the profit impact if Racing
Change in Bicycle can use higher quality raw
Variable Costs materials, thus increasing variable
costs per unit by $10, to generate an
and Sales increase in unit sales from 500 to
Volume 580?

44
Change in Variable Costs and
Sales Volume
580 units × $310 variable cost/unit = $179,800

Sales increase by $40,000, and net operating income

increases by $10,200.
45
 What is the profit impact if RBC:
Change in (1) cuts its selling price by $20 per unit,
Fixed Cost, (2) increases its advertising budget by $15,000
per month, and
Sales Price (3) increases sales from 500 to 650 units per
and Volume month?

46
Change in Fixed Cost, Sales
Price and Volume
650 units × $480 = $312,000

Sales increase by $62,000, fixed costs increase by $15,000, and

net operating income increases by $2,000.
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 What is the profit impact if RBC:
(1) pays a $15 sales commission per bike sold
Change in Variable instead of paying salespersons flat salaries
Cost, Fixed Cost that currently total $6,000 per month, and
(2) increases unit sales from 500 to 575 bikes?
and Sales Volume

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Change in Variable Cost, Fixed Cost and Sales
Volume
575 units × $315 = $181,125

Sales increase by $37,500, fixed expenses decrease by $6,000.

Net operating income increases by $12,375.
49
 If RBC has an opportunity to sell 150
Change in bikes to a wholesaler without
disturbing sales to other customers
Regular or fixed expenses, what price would
it quote to the wholesaler if it wants
Sales Price to increase monthly profits by
$3,000?
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Change in Regular Sales Price

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Learning Objective 4

Find breakeven and target profit

volumes for multiproduct companies

52
 • Sales mix: combination of
products that make up total
sales
• All else equal, company earns
Changing more operating income by
Sales selling high-contribution margin
products
Mix • Weighted-average contribution
margin: weights each
contribution margin by the
relative number of units sold

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Multiproduct Company:
Breakeven in Sales Units (1 of 2)

54
Multiproduct Company: Breakeven in Sales Units
(2 of 2)

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Multiproduct Company: Breakeven in Sales Revenue
(1 of 2)

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Multiproduct Company: Breakeven in Sales Revenue
(2 of 2)

57
 Learning
Objective 5
Determine a firm’s margin of safety,
operating leverage

58
 • Excess of actual or expected
Margin sales over breakeven sales
• Drop in sales the company can
of Safety absorb without incurring a loss
(1 of 2) • Higher margin of safety—less
risky

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Margin of Safety (2 of 2)
Assume Kay generally sells 950 posters a month.

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Margin of Safety—As a
Percentage

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 • Operating Leverage: relative
amount of fixed and variable
costs that make up total costs
Operating • High operating leverage, high
fixed costs, higher contribution
Leverage margin
• Low operating leverage, low
fixed costs, lower contribution
margin

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Characteristics of High Operating Leverage Firms

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Characteristics of Low Operating Leverage Firms

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 • Operating Leverage Factor
(Degree of Operating Leverage):
how responsive a company’s
Operating operating income is to changes
Leverage in sales
• At a given level of sales:
Factor (1 Contribution Margin /
of 2) Operating Income
• Greater the operating leverage
factor, greater impact a change in
sales has on operating income

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Operating Leverage and
Operating Leverage Factor (2 of 2)
• Indicates the percentage change in operating
income that will occur from a 1% change in sales
• Lowest possible value is 1 (i.e. zero fixed costs)
• Example: Assume Kay sells 950 posters per month
• Contribution margin (950 x $14) $13,300
• Less: Fixed expenses 7,000
• Operating income $ 6,300
• Operating leverage factor = $13,300 = 2.11
$6,300

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Operating Leverage and
Operating Leverage Factor (2 of 2)
• % change in OI = OL factor * % change in sales
• If Kay’s sales changes by 1%, her operating income
will change by 2.11% (1% × 2.11).

67
 Exercises &
Problems

68
Quick Check 
Coffee Klatch is an espresso stand in a downtown office
building. The average selling price of a cup of coffee is
$1.49 and the average variable expense per cup is $0.36.
The average fixed expense per month is $1,300. 2,100 cups
are sold each month on average. What is the break-even
sales dollars?
a. $1,300
b. $1,715
c. $1,788
d. $3,129

69
 Quick Check 
Coffee Klatch is an espresso stand in a downtown office
building. The average selling price of a cup of coffee is
$1.49 and the average variable expense per cup is $0.36.
The average fixed expense per month is $1,300. 2,100
cups are sold each month on average. What is the break-
even sales dollars?
a. $1,300 Break-even Fixed expenses
b. $1,715 =
sales $ CM Ratio
BE salesc.$$1,788
= x Current sales $ $1,300
=
(1.49-0.36)/1.49
d. $3,129
= x (2,100 x $1.49)
= $1,715
= $1,715
70
Quick Check 
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per
cup is $0.36. The average fixed expense per month is
$1,300. 2,100 cups are sold each month on average.
What is the break-even sales in units?
a. 872 cups
b. 3,611 cups
c. 1,200 cups
d. 1,150 cups

71
 BE sales = x Current sales

Quick Check = x 2,100

Coffee Klatch is an espresso=stand
1,150incups
a downtown office
building. The average selling price of a cup of coffee is $1.49
and the average variable expense per cup is $0.36. The
average fixed expense per month is $1,300. 2,100 cups are
sold each month on average. What is the break-even sales
Fixed expenses
in units? Break-even = CM per Unit
a. 872 cups
$1,300
b. 3,611 cups =
$1.49/cup - $0.36/cup
c. 1,200 cups
$1,300
d. 1,150 cups =
$1.13/cup
= 1,150 cups
72
 Quick Check 
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. Use the formula method to
determine how many cups of coffee would have to
be sold to attain target profits of $2,500 per month.
a. 3,363 cups
b. 2,212 cups
c. 1,150 cups
d. 4,200 cups

73
 Targeted sales = x Current sales

Quick Check 
= x 2,100

Coffee Klatch is an espresso stand in a downtown office

= 3,363 cups
building. The average selling price of a cup of coffee is
$1.49 and the average variable expense per cup is
$0.36. The Unit salesfixed expense per month is $1,300.
average Target profit + Fixed expenses
to attain
Use the formula method = to determineUnit
howCMmany cups of
target
coffee would profit
have to be sold to attain target profits of
$2,500 per month. $2,500 + $1,300
= $1.49 - $0.36
a. 3,363 cups
b. 2,212 cups $3,800
=
c. 1,150 cups $1.13
d. 4,200 cups = 3,363 cups
74
 Quick Check 
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. Use the formula method to
determine the sales dollars that must be generated
to attain target profits of $2,500 per month.
a. $2,550
b. $5,011
c. $8,458
d. $10,555

75
 Targeted sales $ = x Current sales $

Quick Check  = x (2,100 x $1.49)

= $5,011
Coffee Klatch is an espresso stand in a downtown office
building. The average selling price of a cup of coffee is $1.49
and the average variable expense per cup is $0.36. The
average fixed expense per month is $1,300. Use the formula
method to determine
Sales $the sales dollars that must be
Target profit + Fixed expenses
generated to attain target
to attain = profits of $2,500 per month.
CM ratio
a. $2,550 target profit
b. $5,011 $2,500 + $1,300
=
($1.49 – 0.36) ÷ $1.49
c. $8,458
d. $10,555 $3,800
=
0.758
= $5,011
76
Quick Check 
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup
of coffee is $1.49 and the average variable
expense per cup is $0.36. The average fixed
expense per month is $1,300. 2,100 cups are sold
each month on average. What is the margin of
safety expressed in cups?
a. 3,250 cups
b. 950 cups
c. 1,150 cups
d. 2,100 cups

77
Quick Check 
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per
cup is $0.36. The average fixed expense per month is
$1,300. 2,100 cups are sold each month on average.
What is the margin of safety expressed in cups?
a. 3,250 cups
b. 950 cups
c. 1,150 cups
Margin of safety = Total sales – Break-even sales
d. 2,100 cups = 2,100 cups – 1,150 cups
= 950 cups
78
Quick Check 
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the average
variable expense per cup is $0.36. The average
fixed expense per month is $1,300. 2,100 cups
are sold each month on average. What is the
operating leverage?
a. 2.21
b. 0.45
c. 0.34
d. 2.92

79
Quick Check 
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the average
variable expense per cup is $0.36. The average
fixed expense per month is $1,300. 2,100 cups
are sold each month on average. What is the
operating leverage?
a. 2.21
b. 0.45 Operating Contribution margin
c. 0.34 leverage = Net operating income
d. 2.92 $2,373
= $1,073 = 2.21
80
Quick Check 
At Coffee Klatch the average selling price of a cup of coffee
is $1.49, the average variable expense per cup is $0.36, the
average fixed expense per month is $1,300 and an average
of 2,100 cups are sold each month.
If sales increase by 20%, by how much should net
operating income increase?
a. 30.0%
b. 20.0%
c. 22.1%
d. 44.2%

81
Quick Check 
At Coffee Klatch the average selling price of a cup of coffee
is $1.49, the average variable expense per cup is $0.36, the
average fixed expense per month is $1,300 and an average
of 2,100 cups are sold each month.
If sales increase by 20%, by how much should net
operating income increase?
a. 30.0%
b. 20.0%
c. 22.1%
d. 44.2%

82
The contribution margin is
a. sales revenue minus fixed expenses.
b. sales revenue minus cost of goods sold.
c. sales revenue minus variable expenses.
d. sales revenue minus operating expenses.

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The contribution margin ratio is
a. contribution margin divided by variable
expenses.
b. sales revenue divided by contribution margin.
c. contribution margin divided by sales revenue.
d. fixed expenses divided by variable expenses.

84
On a CVP graph, the breakeven point is
a. the intersection of the total revenue line and
the fixed expense line.
b. the intersection of the total revenue line and
the total expense line.
c. the area between the variable expense line
and the fixed expense line.
d. the area between the total revenue line and
the total expense line.

85
All else being equal, if a company’s variable
expenses increase
a. its breakeven point will decrease.
b. there will be no effect on the breakeven
point.
c. its contribution margin ratio will increase.
d. its contribution margin ratio will decrease.

86
All else being equal, a decrease in a company’s fixed
expenses will
a. increase the sales needed to break even.
b. increase the contribution margin.
c. decrease the sales needed to break even.
d. decrease the contribution margin.

87
Which of the following is true regarding a company
that offers more than one product?
a. Breakeven should be found using a simple
average contribution margin.
b. Breakeven should be found for each product
individually.
c. It has one unique breakeven point.
d. The breakeven point is dependent on sales
mix assumptions.

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A company with a low operating leverage
a. has relatively more risk than a company with
high operating leverage.
b. has relatively more variable costs than fixed
costs.
c. has relatively more fixed costs than variable
costs.
d. has an equal proportion of fixed and variable
costs.

89
For a given level of sales, a company’s operating
leverage is defined as
a. Contribution margin ÷ Operating income.
b. Sales revenue ÷ Contribution margin.
c. Contribution margin ÷ Sales.
d. Operating income ÷ Contribution margin.

90
Which of the following is false regarding choosing between two cost
structures?
a. The indifference point is the point where total revenues
equal total expenses.
b. The indifference point is the point at which costs under two
options are the same.
c. Choose the higher operating leverage option when sales
volume is expected to be higher than the indifference
point.
d. Choose the lower operating leverage option when sales
volume is expected to be lower than the indifference point.

91