Cost Volume Profit Analysis -cvp Exmaples

1 Gross C.M. = Sales - Variable COGM 2 Net C.M. = Sales - Variable COGM - Variable operating expenses Net C. M. = Gross C.M. - Variable operating expenses Example No.1: Total

Per unit

Sale (400 Speakers) Less: Variable Cost

100,000 (60,000)

250 (150)

Contribution Margin Less: Fixed Cost Net Operating Income

40,000 (35,000) 5,000

100

Explaination of change in activity affect Contribution Margin & Net Operating Income: On Sale of 1 Speaker: Total

Per unit

Sale (1 Speaker) Less: Variable Cost

250 (150)

250 (150)

Contribution Margin Less: Fixed Cost

100 (35,000)

100

Net Operating Loss

(34,900)

On Sale of 2 Speakers: Total

Per unit

Sale (2 Speakers) Less: Variable Cost

500 (300)

250 (150)

Contribution Margin Less: Fixed Cost

200 (35,000)

100

Net Operating Loss

(34,800)

On Sale of 350 Speakers: Total

Per unit

Sale (350 Speakers) Less: Variable Cost

87,500 (52,500)

250 (150)

Contribution Margin Less: Fixed Cost

35,000 (35,000)

100

Net Operating Income

-

On Sale of 351 Speakers: Total

Per unit

Sale (351 Speakers) Less: Variable Cost

87,750 (52,650)

250 (150)

Contribution Margin Less: Fixed Cost

35,100 (35,000)

100

Net Operating Income

Increased in numbers of speakers sold Contribution margin per speaker Increase in Net Operating Income

CONTRIBUTION MARGIN RATIO:

100

25 x $ 100 2,500

Or:

C. M. Ratio =

TotalContribution Margin Total Sales

C. M. Ratio =

Contribution Margin Per unit Sales price Per unit

40,000 100,000 100 250

Impact on Net Operating Income on changes in Sales, by C.M. ratio: Calculation of changes in net income, with the changes in sales, without I/S Increase in Sales 30,000 C.M. ratio 40% Increase in Net operating Income

12,000

Decrease in Sales C.M. ratio

40,000 40%

Decrease in Net operating Income

16,000

There is a direct relationship or proportion between sales and contribution margin as well as net income

Proof:

Present

Sales Less: Variable Cost Contribution Margin Less: Fixed Cost Net Operating Income

Some Applications of CVP Analysis:

Expected Changes

100,000 130,000 (60,000) (78,000) 40,000

52,000

(35,000) (35,000) 5,000

17,000

Percentage

30,000 100% (18,000) 60% 12,000 40% 12,000

Consider the following example: Selling Price per unit Variable Cost per unit C. M. (in amount) C.M. Ratio Fixed Cost Current Sales (in units)

250 150 100 40% 35,000 per month. 400

Concept No.1: (Change in Fixed Cost and Sales Volume): Sales manager feels that by increase in $10,000 fixed cost i.e, advertising budget, then the sale will increase by $30,000 to a total 520 units. Should the advertising budget increase, Expected total contribution margin ($130,000 x 40%)

52,000

Present total contribution margin ($100,000 x 40%)

40,000

Increase in Contribution Margin Increase in fixed cost Increase in Net Operating Income

12,000 10,000 2,000

OR Increase in sales Contribution Margin ratio

30,000 40%

Increase in Contribution Margin Increase in fixed cost Increase in Net Operating Income

12,000 10,000 2,000

OR Proof: Sales Less: Variable Cost Contribution Margin

Present

Expected Changes

100,000 130,000 (60,000) (78,000) 40,000

52,000

Percentage

30,000 100% (18,000) 60% 12,000 40%

Less: Fixed Cost

(35,000) (45,000)

Net Operating Income

5,000

7,000

(10,000) 2,000

Concept No.2: (Change in Variable Cost and Sales Volume): Assumption: Management consider to change the part with more high quality part. This will increase the variable cost by $10 which decrease the contribution margin by $ 10. It increases the sales to 480 speakers. Should this changes incorporated:

Expected total contribution margin (480 Speakers x $ 90)

43,200

Present total contribution margin (400 speakers x $100)

40,000

Increase in Contribution Margin

3,200

OR Proof: Sales Less: Variable Cost

Present

Expected Changes

100,000 120,000 (60,000) (76,800)

20,000 (16,800)

Contribution Margin

40,000

Less: Fixed Cost

43,200

3,200

(35,000) (35,000)

Net Operating Income

5,000

8,200

3,200

Concept No.3: (Change in Fixed Cost, Sales Price and Sales Volume): Assumption: Management consider to cut the selling price by $20 per speaker, increases fixed cost by $15,000 in advertising budget per month, these changes increases the sales by 50% i.e. 600 speakers. Should this changes incorporated: Expected total contribution margin (600 speakers x $80)

48,000

Present total contribution margin (400 speakers x $ 100)

40,000

Increase in Contribution Margin Increase in fixed cost Decrease in Net Operating Income

8,000 15,000 (7,000)

OR Proof:

Present

Expected

Sales Less: Variable Cost

100,000 (60,000)

250 (150)

138,000 (90,000)

230 (150)

Contribution Margin

40,000

100

48,000

80

Less: Fixed Cost

(35,000)

(50,000)

Net Operating Income

5,000

(2,000)

Concept No.4: (Change in Variable Cost, Fixed Cost and Sales Volume): Assumption: Management decided to pay $15 per speaker commission to Sales person and stop payment of $6,000 fixed amount of salaries, this change will increase the monthly sales by 15% i.e. to 400 speakers to 460 speakers per month. Should this changes incorporated: Expected total contribution margin (460 speakers x $85)

39,100

Present total contribution margin (400 speakers x $100)

40,000

Decrease in Contribution Margin Decrease in fixed cost Increase in Net Operating Income

(900) 6,000 5,100

OR Proof:

Present

Expected

Sales Less: Variable Cost

100,000 (60,000)

250 (150)

115,000 (75,900)

250 (165)

Contribution Margin

40,000

100

39,100

85

Less: Fixed Cost Net Operating Income

(35,000)

(29,000)

5,000

10,100

perating Income:

40%

40%

ution margin

ercentage

ercentage

Changes 38,000 (30,000) 8,000 (15,000)

(7,000)

Changes 15,000 (15,900) (900)

6,000 5,100

Break even Analysis: ### Computation of Break even analysis by Equation method: Break even point (in amount) Sale = Variable cost + Fixed Cost + Desired Profit

### Computation of Break even analysis by Formula: Break even point (in amount) =

Break even point (in units) =

Fixed Cost C.M. Ratio

Fixed Cost C.M. per unit

Target Profit Analysis: It is also done by break even analysis (equation method)

Margin of Safety: Margin of safety is the excess of budgeted (or actual) sales over the break even sales. BEP provided the line below which company suffered loss. Higher the margin of safety, the lower the risk of not breaking even. a) Margin of Safety = Total Sales (actual) - Break even sales b) Margin of Safety (in Percentage) =

Margin of Safety (in amount) Total budeted (or actual) sales

c) In a single product firm, the margin of safety can also be expressed in terms of number of units. Margin of Safety (in units) = Margin of Safety (in amount) Sales price per unit Or Margin of Safety (in units) = Actual units sold - BEP (in units) Example: ### MOS =

$100,000 - $87,500

$ 12,500

### MOS (%) =

$ 12,500 $100,000

12.5%

### MOS (in units) =

$ 12,500 $250

50 units

MOS (in units) =

400 speakers - 350 speakers

MOS (in units) =

50 units

Operating Leverage: It is a measure of how sensitive net operating income is to percentage changes in sales. It means that if operating leverage is high then the small percentage change can produce large increasein net income and vice versa. Example: Sales Less: Variable cost

Farm A Farm B 100,000 100,000 (60,000) (30,000)

Contribution Margin Less: Fixed Cost Net Operating Income

Degree of operating leverage =

40,000 (30,000) 10,000

70,000 (60,000) 10,000

Contribution Margin Net operating Income

DOL (A)=

40,000 10,000

4 times

DOL (B)=

70,000 10,000

7 times

Consider the impact of change of 10% increase in sales of two companies

Sales Less: Variable cost

Farm A 10% 100,000 110,000 (60,000) (66,000)

Farm B 100,000 (30,000)

Contribution Margin Less: Fixed Cost Net Operating Income

40,000 (30,000) 10,000

70,000 (60,000) 10,000

44,000 (30,000) 14,000

Change in Net Operating Income (in amount)

4,000

Change in Net Operating Income (in times)

4,000 10,000

Changes in Percentage

40

Consider the impact of change of 12% decrease in sales of two companies

Sales Less: Variable cost

Farm A 12% 100,000 88,000 (60,000) (52,800)

Farm B 100,000 (30,000)

Contribution Margin Less: Fixed Cost Net Operating Income

40,000 (30,000) 10,000

70,000 (60,000) 10,000

35,200 (30,000) 5,200

Change in Net Operating Income (in amount)

(4,800)

Change in Net Operating Income (in times)

(4,800) 10,000

Changes in Percentage

(48)

of safety, the

es in sales. an produce

Farm B 10% 110,000 (33,000) 77,000 (60,000) 17,000 7,000 7,000 10,000 70

Farm B 12% 88,000 (26,400) 61,600 (60,000) 1,600 (8,400) (8,400) 10,000 (84)

Review Problem Total Sales Less: Variable cost Contribution Margin Less: Fixed Cost Net Operating Income

1,200,000 (900,000) 300,000 (240,000) 60,000

Per unit

Percentage of Sales 60 100% (45) 15

Required: 1 Compute Company's C. M ratio and Variable expense ratio. 2 Compute the company's break even point (in units) and (in dollars), by equation method. 3 Assume that sales increase by $400,000 next year. If cost behaviour pattern remain constant, by how much will the company net operating income increase? Use the C.M. ratio to determine your answer. 4 Refer to the original data. Assume that next year management wants the company earn a min. profit of $ 90,000. How much units will have to be sold to meet this target profit figure? 5 Refer, to the original data, Compute the company's margin of safety (in dollar) and (in percentage) 6 a Compute the company degree of operating leverage at the present level of sale b Assume that through a more intense effort by the sales staff the company sale increase by 8% next year. By what percentage would you expect ner operating income increases? Use the operating leverage concept. c Verify your answer through Income Statement. 7 In an effort to increase the sales and profit, management is considering the use of a higher quality speaker. The higher quality speaker would increase the variable cost by $3 per unit, but management could eliminate one quality inspector who is paid a salary of #30,000 per year. The sales manager estimate that the higher quality speaker would increase annual sales by atleast 20%. a) Assuming that chanes are made as described above, prepare projected

income statement for next year. Show a data on a total, per unit and percentage basis. b) Compute the company's new breakeven point in both units and dollar of sales. Use C.M method. c) Would you recommend that the change be made?

equation method.

attern remain constant, C.M. ratio to

he company

ny sale increase ncome increases?

the use of e variable cost ho is paid a quality speaker

rcentage basis.

r of sales.

Req (I)

ContributionMargin Ratio and Variable cost ratio: CONTRIBUTION MARGIN RATIO: C. M. Ratio = TotalContribution Margin Total Sales

Or:

C. M. Ratio = Contribution Margin Per unit Sales price Per unit VARIABLE COST RATIO: Variable Cost ratio =

Req (II)

Variable Cost Sales

Computation of Break even analysis by Equation method: Break even point (in amount) Sale = Variable cost + Fixed Cost + Desired Profit X = 0.75X +240,000 + 0 0.25 X = 240,000 X = 240,000 / 0.25 X = Sales = 960,000

Break even point (in units) = Amount of BEP (in Amount) Sales price per unit

Req (III)

Impact on Net Operating Income on changes in Sales, by C.M. ratio: Calculation of changes in net income, with the changes in sales, without I/S Increase in Sales 400,000 C.M. ratio 25% Increase in Net operating Income

Req (IV)

Target Profit of $ 90,000

Sale = Variable cost + Fixed Cost + Desired Profit X = 0.75X +240,000 + 90,000 0.25 X = 330,000 X = 330,000 / 0.25 X = Sales = 1,320,000 Nos. of units to be sold to earn $ 90,000: = Amount of Sales Sales price per unit

Req (V)

Margin of Safety (in amount) and (in percentage)

a) Margin of Safety = Total Sales (actual) - Break even sales Margin of Safety =

1,200,000 - 960,000

Margin of Safety =

240,000

b) Margin of Safety (in Percentage) =

Margin of Safety (in Percentage) =

Margin of Safety (in amount) Total budeted (or actual) sales

240,000 1,200,000

20

Req (VI) a) Degree of Operating Leverage

Degree of operating leverage =

Contribution Margin Net operating Income DOL =

DOL =

300,000 60,000 5 times.

b) Impact on Net Income, When Sales increases 8% by the help of DOL

Increase in Sales DOL =

8%

5 times

Increase in Net Operating Income =

8% x 5 times

Increase in Net Operating Income =

40%

c) Verify the answer by Income Statement: Increase by

Sales Less: Variable cost Contribution Margin Less: Fixed Cost Net Operating Income

1,200,000 (900,000)

8% 1,296,000 (972,000)

300,000 (240,000) 60,000

324,000 (240,000) 84,000

Change in Net Operating Income (in amount)

24,000

Change in Net Operating Income (in times)

24,000 60,000

Changes in Percentage

40

Req (VII) a) Changes in Variable Cost, Sales and Fixed Cost: Present

Sales Less: Variable cost Contribution Margin Less: Fixed Cost Net Operating Income

Rate

1,200,000 (900,000)

60 (45)

300,000 (240,000) 60,000

15

Expected 1,440,000 (1,152,000)

b) Break even Sales (in amount) and (in units) by CM Ratio:

Computation of Break even analysis by Formula:

288,000 (210,000)

78,000

Break even point (in amount) =

Break even point (in units) =

Fixed Cost C.M. Ratio

210,000 20%

Fixed Cost C.M. per unit

210,000 12

c) Yes, the proposed changes will incorporate because from these changes company earn $18,000 more than Present level.

300,000 1,200,000

25

15 60

25

900,000 1,200,000

75

960,000 60

s, by C.M. ratio:

ales, without I/S

100,000

16,000 units

tual) sales

help of DOL

1,320,000 60

22,000 units

Rate 60 (48) 12

Percent 100 (80) 20

1,050,000

17,500

changes company