Chapter 6
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Cost-volume-profit (CVP) analysis focuses on the following factors:
1.The
prices of products or services
2.The
volume of products or services produced and sold
3.The per-unit variable costs
4.The total fixed costs
5.The mix of products or services produced

Major assumptions of CVP analysis include:
1
Selling price is constant throughout the entire relevant range.
2
Costs are linear throughout the relevant range.
3
Sales mix to calculate the weighted-average contribution margin is constant.
4
The amount of inventory is constant.

TRADITIONAL
Sales
Less: Cost of Goods Sold:
Variable Costs
Fixed Costs
$350
150
$1,000
Total Cost of Goods Sold
Gross Profit
Less: S, G, & A Costs:
Variable Costs
Fixed Costs
Total S, G, & A Costs
Net Operating Income
$ 50
250
$ 500
$ 500
300
$ 200
CONTRIBUTION MARGIN
Sales
Less: Variable Costs:
Manufacturing
Costs
S, G, & A Costs
Total Variable Costs
$350
50
Contribution Margin
Less: Fixed Costs:
Manufacturing Costs $150
S, G, & A Costs
Total Fixed Costs
250
Net Operating Income
$1,000
$ 400
$ 600
400
$ 200

Happy
Daze
Game Co.
Contribution margin (per unit) =
Contribution margin (in $)/Units sold
= $28,000/8,000 = $3.50
Sales (8,000 units)
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Total Contribution
Margin Per
$100,000 unit
$12.50
72,000
$ 28,000
35,000
Net Operating Income (Loss) $ (7,000)
9.00
$3.50

Total
Sales (8,000 units) $100,000
Less: Variable Costs 72,000
Contribution Margin $ 28,000
Less: Fixed Costs 35,000
Net Operating Income (Loss) $ (7,000)
Happy Daze’s
Contribution Margin =
$28,000
$100,000
= 28%

Applying the
Contribution Margin Ratio
For every dollar change in sales, contribution margin will increase or decrease by the contribution margin ratio multiplied by the increase or decrease in sales dollars.
If Sales Decrease
Sales Dollar Decrease
200 units x $12.50
x
200 units:
Contribution
Margin Ratio
=
Decrease in
Contribution
Margin and
Net
Operating
Income
$2,500 X
28% = $700

Companies must also consider qualitative factors when choosing options that affect its bottom line.
What if a less expensive supplier is less reliable or provides inferior quality material?
????
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What if reducing labor causes more machine costs, trading variable costs for fixed costs ?
What if using inexperienced workers causes more defective products?

The break-even point is the level of sales at which contribution margin just covers fixed costs and consequently net operating income is equal to zero.
Break-Even
(units)
=
Fixed Costs
Contribution Margin Per Unit
Break-Even
(Sales $)
=
Fixed Costs
Contribution Margin Per Unit

Break-Even Calculations for Multiple
Products
When more than one product is produced and sold, managers must calculate a
“weighted average” contribution margin for all products and estimate the sales mix.
Break-Even (Units) =
Fixed Costs
Weighted Average
Contribution Margin Per Unit

Relationship between Weighted-Average
Contribution Margin and Break-Even
Point
As Weighted-
Average
Contribution
Margin
INCREASES
The
Break-Even
Point will
DECREASE.

Target Profit Analysis
(Before and After Tax)
Sales volume
(to reach a target profit before tax)
Fixed Cost + Target Profit
(before tax)
=
Contribution Margin per Unit

It is also important to consider the payment of income taxes in the target profit formula.
If a company wants to earn $100,000 in target profit after taxes, and has a 35% income tax rate, what must its before-tax target profit be?
Before-tax Profit =
=
After-tax Profit
(1 – Tax Rate)
$100,000
(1 – 35%)
=
$153,846
(rounded)

Sales Volume to Reach an
After-Tax Target Profit
If a company has fixed cost of $35,000, a contribution margin per unit of $3.50, and desires an after-tax profit of $100,000, how many units must it sell?
Sales Volume to
Reach After-tax
Target Profit
=
=
Fixed Costs + Before-tax Profit
Contribution Margin per Unit
$35,000 + $153,846
$3.50
=
53,956 units

Cost structure refers to the relative proportion of fixed and variable costs in a company.

• The measure of the proportion of fixed costs in a company’s cost structure.
• It is used as an indicator of how sensitive profit is to changes in sales volume.
Operating
Leverage
=
Contribution Margin
Net Operating Income