What is cost-volume-profit (CVP) analysis
Studies how changes in costs and volume affect profit
5 basic components of CVP
- volume (quantity)
- unit selling price
- unit variable cost
- total fixed costs
- sales mix
What assumptions does CVP make
- costs and revenues are linear in the relevant range
- costs are either fixed or variable
- activity is the only cost driver
- all units produced are sold
- sales mix remains constant
What is contribution margin
Amount remaining to cover fixed costs and profit
Revenue - Variable Cost
CM per unit and CM ratio formulas
CM per unit = selling price - variable cost per unit
CM ratio = CM per unit / selling price
What is the break even point
where total revenue = total costs
Profit = 0
Break even formulas for units and dollars
BE units = fixed costs / CM per unit
BE dollars = fixed costs / CM ratio
Required sales formulas for target income before tax (units and dollars)
Units = (fixed costs + target income) / CM per unit
Dollars = (fixed costs + target income) / CM ratio
Formula for before-tax income
Before tax income = after tax income / (1 - tax rate)
What is margin of safety
Actual sales - break even sales
higher margin means lower risk
Margin of safety formulas (MOS $ and ratio)
MOS $ = actual sales - break even sales
MOS ratio = MOS / actual sales
What is sales mix
Relative proportions of products sold
How to calculate break-even with multiple products (units)
- find weighted avg CM per unit
- break even units = fixed costs / weighted avg CM
How to calculate break-even in dollars (multiple products)
- find weighted avg CM ratio
- break even dollars = fixed costs / weighted avg CM ratio
Degree of Operating Leverage equation and what is it, and when is each best
CM/OI
For every 1% increase in sales, the increase % in income. Lower is better for in an uncertain market, but higher is better for stable market since you get greater return.
