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Chapter 7 Cost-Volume-Profit Analysis The Break-Even Point The break-even point is the point in the volume of activity where the organization's revenues and expenses are equal. Equation Approach Contribution-Margin Approach For each additional surf board sold, Curl generates $200 in contribution margin. Contribution-Margin Approach Contribution-Margin Approach Here is the proof! Contribution Margin Ratio Calculate the break-even point in sales dollars rather than units by using the contribution margin ratio. Contribution Margin Ratio Graphing Cost-Volume-Profit Relationships Viewing CVP relationships in a graph gives managers a perspective that can be obtained in no other way. Consider the following information for Curl, Inc.: Cost-Volume-Profit Graph Cost-Volume-Profit Graph Cost-Volume-Profit Graph Cost-Volume-Profit Graph Cost-Volume-Profit Graph Profit-Volume Graph Target Net Profit We can determine the number of surfboards that Curl must sell to earn a profit of $100,000 using the contribution margin approach. Equation Approach Effect of Income Taxes Applying CVP Analysis Safety Margin The difference between budgeted sales revenue and break-even sales revenue. The amount by which sales can drop before losses begin to be incurred. Safety Margin Curl, Inc. has a break-even point of $200,000. If actual sales are $250,000, the safety margin is $50,000 or 100 surf boards. Changes in Fixed Costs Curl is currently selling 500 surfboards per year. The owner believes that an increase of $10,000 in the annual advertising budget, would increase sales to 540 units. ? Should the company increase the advertising budget? Changes in Fixed Costs Changes in Fixed Costs Changes in Unit Contribution Margin Because of increases in cost of raw materials, Curl's variable cost per unit has increased from $300 to $310 per surfboard. With no change in selling price per unit, what will be the new break-even point? Changes in Unit Contribution Margin Suppose Curl, Inc. increases the price of each surfboard to $550. With no change in variable cost per unit, what will be the new break-even point? CVP Analysis with Multiple Products For a company with more than one product, sales mix is the relative combination in which a company's products are sold. Different products have different selling prices, cost structures, and contribution margins. Let's assume Curl sells surfboards and sail boards and see how we deal with break-even analysis. CVP Analysis with Multiple Products Curl provides us with the following information: CVP Analysis with Multiple Products Weighted-average unit contribution margin CVP Analysis with Multiple Products Break-even point CVP Analysis with Multiple Products Break-even point Assumptions Underlying CVP Analysis ? Selling price is constant throughout the entire relevant range. ? Costs are linear over the relevant range. ? In multi-product companies, the sales mix is constant. ? In manufacturing firms, inventories do not change (units produced = units sold). CVP Relationships and the Income Statement CVP Relationships and the Income Statement Cost Structure and Operating Leverage The cost structure of an organization is the relative proportion of its fixed and variable costs. Operating leverage is . . . - the extent to which an organization uses fixed costs in its cost structure. - greatest in companies that have a high proportion of fixed costs in relation to variable costs. Measuring Operating Leverage Measuring Operating Leverage A measure of how a percentage change in sales will affect profits. If Curl increases its sales by 10%, what will be the percentage increase in net income? Measuring Operating Leverage End of Chapter 7