BEC 2
Strategic Planning
Cost volume profit analysis (Breakeven Analysis): allows managers to anticipate profits at
different levels of sales and production volume. point at which revs = total costs
Cost is dependent on volume.
Total Costs=FC + VC/unit
Assumptions
All costs behave in linear fashion in relation to production volume over LT
Cost behaviors are anticipated to remain constant over relevant range of production volume be
there is an assumption that the efficiency of production does not change.
Costs show greater variability over time. The longer the time period, the greater the % variable
costs, the shorter the time period, the greater % of fixed costs.
Contribution Margin Approach (Direct Costs) is used rather than Absorption Costing
Revenue
Less VC (DM+DL+Variable MOH + Variable SGA + shipping)
CM
Less FC (Fixed OH + Fixed Selling + most general and admin)
Net Income
Unit Contribution Margin: Unit SP-Unit VC
Contribution Margin Ratio=CM/revenue (expressed as Total $ or per unit)
Absorption Costing (product v period costs) matching principle
Revenue
Less COGS (DM+DL+Variable MOH +Fixed MOH)
Gross Margin
Less Operating Exp (Fixed & Variable SGA)
Net Income
Absorption Method (GAAP)
Contribution Method (Internal)
SG &A are period costs under both methods.
CM Approach: Variable SG&A costs are part of total VC for CM calculation
Absorption Approach: SG&A part of operating expenses reported separately from COGS
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BEC 2
Strategic Planning
MAJOR DIFFERENCE in Contribution vs Absorption: Factory OH - SG&A expensed immediately
CM Approach: all Fixed FOH is a period costs and is expensed in period incurred. Inventory
includes only VARIABLE manufacturing costs, so COGS includes only variable MOH costs.
Absorption Approach: all Fixed FOH is treated as product costs and is included in inventory values.
COGS includes both variable and fixed costs.
Effect on Income: If every unit produced is sold ever period, operating income will be same for
both methods. If # units sold is more or less than # units produced, operating income figures will
be different.
Step 1) Fixed cost per unit (Fixed MOH/units produced)
Step 2) Change in Income (Change in inventory units x FC per unit)
Step 3) Determine impact of change in income:
No change inventory: absorption NI = variable NI
Increase inventory: absorption NI > variable NI
Decrease inventory: absorption NI < variable NI
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BEC 2
BE in units = Total FC/CM per unit
CM per unit = SP/unit - VC/unit
BE in $$ = SP per unit x BE units
CM Ratio = CM/Sales per unit or $
Strategic Planning
OR
$Sales @BE/ SP per unit
OR
Total FC/CM ratio
Total Sales dollars at BEP = Total Variable costs + Total FC
Unit Sales price x Units at BEP = (Units at BEP + Variable cost per unit) + Total FC
Required Sales Volume for Target Profit
Sales = VC+ (FC + Desired NI before taxes) OR
Sales = (FC + desired profit or EBT)/ CM ratio
Target profit before tax = Target profit after tax/ (1-Taxrate)
Profit after BE = # units sold after BE x CM per unit
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BEC 2
Strategic Planning
Also 150+60/75 per unit (CM per unit)
Predicting profit - company’s profit after BE
Margin of Safety: excess sales over BE sales
Margin of Safety = Total Sales-BE Sales
Margin of Safety % = Margin of Safety in Dollars/Total Sales
Target Costing: technique used to establish the product cost allowed to ensure both profitability per
unit and total sales volume.
Target Cost of Product = market price- required profit
Transfer pricing: price charged for good/service by one division to another. Prices may be based on
mkt, cost, a negotiated amount or dual pricing (revenue to one segment is not the same as cost to
another segment).
Marginal Analysis: focuses on future revenues and costs that are associated w/ a decision.
*All Irrelevant (sunk - unavoidable) costs should be ignored if they do not differ between
alternatives.
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BEC 2
Strategic Planning
If Excess Capacity, Accept if SP > VC (relevant costs)
If Full Capacity, Accept SP > VC + opportunity costs
If relevant costs to make + opportunity costs of making < outside purchase price, MAKE IT!
Make vs buy if relevant cost to make (including OC) < outside purchase $ = make it
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BEC 2
Strategic Planning
Only costs that change as a result of decision are relevant.
Controllable costs are those that can be authorized at a specific level of mgmt.
Uncontrollable costs are costs that were authorized at a different level.
Differential costs is the difference between two alternatives.
Differential revenue is the difference in revenue that results from choosing one action over another
Sell of Process further: based on profitability. If incremental rev > inc cost = process further
Joint Costs (sunk cost): costs of a single process that yields multiple products. Joint costs can’t be
traced to an individual product. In a Sell or process further decisions, joint costs are irrelevant.
Split-Off point: point in process where products become identifiable
Separable Costs (relevant): costs incurred after split off that can be traced to individual products.
Always relevant to decisions of whether to sell or process further.
**The decision on whether to sell at split off point is made by comparing the incremental cost and the
incremental revenue generated after split-off.
IF incremental revenue > incremental costsprocess further!
IF incremental revenue < incremental costssell at split-off!
Add or Drop a Segment (product line): decision is made after comparing the FC that can be avoided
if the segment is dropped (the cost of running the segment), to the contribution margin that will be
lost if segment is dropped.
IF lost CM (cost) > avoidable FC  KEEP!
IF lost CM (cost) < avoidable FC  drop!
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BEC 2
Strategic Planning
Benchmarking: adopting best practices of different firms to establish standards.
Sensitivity Analysis:
Process of experimenting w/ different parameters and assumptions regarding a model and
cataloging the range of results to view the possible consequences of a decision. Use probabilities to
approximate reality.
Forecasting Analysis (probability/risk): extension of sensitivity analysis by predicting future
values of a dependent variable (total costs) using information from previous time periods.
Regression Analysis: method for studying relationship between two or more variables.
A) Simple Linear Regression: involves only ONE independent variable. (Multiple regression
involves more than one independent variable)
TC = VC (#units) + FC OR
y=mx+b
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BEC 2
Strategic Planning
Coefficient of Correlation (r) - strength of linear relationship between independent and dependent
variables.
**When selecting cost drivers, choose the one w/ highest “r” or “r2”
Coefficient of Determination (R2): the proportion of total variation in dependent variable(y)
explained by independent variable (x). Value lies between 0-1. (1 is 100% explained by x)
The higher the R2, the greater is proportion of total variation in y that is explained by variation x.
High Low method: estimate fixed and variable cost
(High Costs- Low Cost)/ (high units –low units) = variable cost per unit
(Costs) / (volume)
Flexible budget formula:
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BEC 2
Strategic Planning
PLANNING TECHNIQUES:
Master Budget is comprised of operating budget and financial budget prepared in anticipation of
achieving a single level of sales volume for a specified period of time.
Operating Budgets Include:
Sales Budgets
Production Budgets
Selling & Admin Budgets
Personnel Budgets
Financial Budgets Include:
Pro-forma f/s
Cash budgets
Sales forecast made first - input received from numerous resources
Production budget - amounts spent on DL DM and FOH - trying to balance for inventory over/short
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BEC 2
Strategic Planning
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BEC 2
Strategic Planning
FOH budget - IM + IL + Factory costs
COGM and sold
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BEC 2
Strategic Planning
Financial budgets - cash budget - divided into cash available, cash disbursements, financing
Pro-forma FS: done last - IC, BS and CFS
Capital budget - generally noncurrent assets
Flexible budgeting - used with most budgets and in most industries
Variance analysis - budgeted amounts to actual
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BEC 2
Strategic Planning
BUDGET VARIANCE ANALYSIS - adjust master budget to create flexible
Currently attainable standards: Use with flexible budgets.
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BEC 2
DM and DL variance
DM price variance=
DM qty variance=
DL rate variance=
DL efficiency variance=
Strategic Planning
Actual qty x (actual price-standard price)
Standard price x (actual qty-standard qty)
Actual hrs worked x (actual rate-standard rate)
Standard rate x (actual hrs-standard hours)
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BEC 2
Strategic Planning
MOH Variance - ABA BSA
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BEC 2
Strategic Planning
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BEC 2
Strategic Planning
Sales price variance:
Sales volume variance
Market size variance
Financial scorecards: CRPI - 4 financial measures managers can be held accountable
Cost
Revenue
Profit
Investment
Accurate/timely, understandable, specific accountability
Contribution reporting: profit in relation to controllable costs
Controllable margin = CM - controllable FC
Balanced Scorecard - FICA
Financial
Internal business process
Customer satisfaction
Advancement of innovation (HR development)
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