1 financial modeling for short-term decision-making chapter 6 managerial accounting 11e...
TRANSCRIPT
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Financial Modeling for Short-Term
Decision-Making
CHAPTER 6
Managerial Accounting 11E
Maher/Stickney/Weil
PowerPointPowerPoint Presentation by Presentation by
LuAnn BeanLuAnn BeanProfessor of AccountingProfessor of AccountingFlorida Institute of TechnologyFlorida Institute of Technology
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in
part, except for use as permitted in a license distributed with a certain product or service or
otherwise on a password-protected website for classroom use.
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CHAPTER GOAL
This chapter explains and illustrates financial modeling. Financial modeling canProvide an overview of an organization’s financial
activitiesHelp managers make specific decisions
Financial modeling relies on concepts of fixed and variable cost behavior.
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FINANCIAL MODEL
Financial modeling enables analysts to test the interaction of economic variables in a variety of settings. It requires analysts to develop a set of equations that represents a company’s operating and financial relations.
Financial modeling enables analysts to test the interaction of economic variables in a variety of settings. It requires analysts to develop a set of equations that represents a company’s operating and financial relations.
LO 1
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COST-VOLUME-PROFIT (CVP)
CVP can be used to answer questions such as What effect on profit can GM expect if it builds a
larger SUV?How will NBC’s profit change if ratings increase
for its evening news program?How many subscribers must a Dish Network
obtain to break even for the year?What happens if Verizon reduces fees charged to
customers?
LO 2
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EXAMPLE: Early Horizons Daycare
Early Horizons Daycare is a daycare center that defines a unit of output as “service provided for 1 child for a month.” Building capacity is 30 children. An accountant developed the following estimates:
LO 2
Continued
Price per child per month $ 600
Variable cost per child per month 200
Fixed costs per month 5,000
EHD
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CAPACITY and COSTS Early Horizons Daycare has a capacity of 20
units (relevant range), after which it must hire more staff.Variable costs include
Snacks and food Supplies A portion of insurance
Fixed costs include:Rent and utilitiesA portion of insuranceMinimum staffing
LO 2EHD
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BREAK-EVEN POINT: DefinitionBREAK-EVEN POINT: Definition
Is the point in the basic CVP model where revenues equal
costs.
Total Revenue = Total Costs
LO 2
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BREAK-EVEN: Table Format
Using break-even computations:
LO 2
Sales Revenue (12.5 X $600) $ 7,500
Less Variable costs (12.5 X $200) 2,500
Contribution Margin (CM) $ 5,000
Less Fixed costs 5,000
Operating profit $ 0
EHD
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CONTRIBUTION MARGIN: Definition
CONTRIBUTION MARGIN: Definition
Is the excess of revenue over variable costs.
Total Revenue – Variable Costs
LO 2
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Can we use contribution margin
to compute break- even (BE) volume?
YES!
BE Volume =
Fixed cost / CM per child
LO 2MANAGERS WANT TO KNOW!EHD
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CONTRIBUTION MARGIN APPROACH
Using the contribution margin approach:
LO 2EHD
Break-even Volume = Fixed Costs / CM per child= $5,000 / $400
= 12.5 children
Click the button to skip equation approach
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EQUATION APPROACHUsing the equation approach (Operating profit at break-even = 0):
LO 2EHD
Operating profit 0= Sales revenue - Costs
= Sales revenue -Variable costs (VC) – Fixed costs (FC)
= (Unit selling price (SP) × Sales volume) - (VC per unit × Sales volume) - FC ($600 - $200) × Sales volume = $5,000
Sales volumeBE = $5,000/$400 = 12.5 children/month
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Can we graph the relationships in CVP
analysis?
YES!
LO 2MANAGERS WANT TO KNOW!
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LO 2
EXHIBITEXHIBIT 6.16.1
By graphing revenues
and costs on same graph,
you can find BE,
profit and loss areas.
By graphing revenues
and costs on same graph,
you can find BE,
profit and loss areas.
Break-even Volume = Fixed Costs / CM
EHD
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LO 2
EXHIBITEXHIBIT 6.26.2
Slope of line is
variable cost per
unit.
Slope of line is
variable cost per
unit.
Break-even Volume = Fixed Costs / CM
EHD
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TARGET PROFIT: CM Approach
LO 2
Target profit Volume = (Fixed costs + Target Profit) / CM
= ($5,000 + $3,000) / $400
Sales revenue (20*$600) $ 12,000
Less Variable costs (20*$200) 4,000
Contribution Margin $ 8,000
Less Fixed costs 5,000
Operating profit $ 3,000
EHD
Continued
# children = 20
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TARGET PROFIT: Equation Approach
LO 2
Sales revenue – Variable costs - Fixed costs = Operating Profit
($600 - $200) × Sales volume - $5,000 = $3,000
$400*Sales volume = $8,000
Sales revenue (20 X $600) $ 12,000
Less Variable costs (20 X $200) 4,000
Contribution Margin $ 8,000
Less Fixed costs 5,000
Operating profit $ 3,000
EHD
Continued
Sales volume = 20 children
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TARGET PROFIT: Reminder
LO 3
Target profit Volume = (Fixed costs + Target Profit) / CM
Sales revenue (20 X $600) $ 12,000
Less Variable costs (20 X $200) 4,000
Contribution Margin $ 8,000
Less Fixed costs 5,000
Operating profit $ 3,000
EHD
Continued
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EARLY HORIZONS DAYCARE: Sensitivity Analysis
EARLY HORIZONS DAYCARE: Sensitivity Analysis
Assumptions
Price/child $ 600 $ 600 $ 600 $ 660
VC/child $ 200 $ 200 $ 210 $ 200
Monthly FC $5,000 $4,500 $5,000 $5,000
Children enrolled 20 20 20 18
Model results: IS
Sales revenue $ 12,000 $ 12,000 $ 12,000 $ 11,880
Less VC 4,000 4,000 4,200 3,600
Total CM $8,000 $8,000 $7,800 $ 8,280
Less FC 5,000 4,500 5,000 5,000
Operating profit $3,000 $3,500 $2,800 $ 3,280
LO 3
Base Cost FC $500 VC $10 Price $60, Vol. 2Alt #1 Alt #2 Alt #3
EHD
EX
HIB
ITE
XH
IBIT
6.36.3
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MARGIN OF SAFETY: DefinitionMARGIN OF SAFETY: Definition
Is the excess of projected (or actual) sales units over Break-
even unit sales level.
Sales units – BE Sales units or
Sales dollars – BE Sales dollars
LO 3
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COST STRUCTURE: DefinitionCOST STRUCTURE: Definition
Refers to the proportion of fixed and variable costs to total costs.
LO 4
OPERATING LEVERAGE: Definition
OPERATING LEVERAGE: Definition
Is the extent to which an organization’s cost structure is made up of fixed costs.
Note: the higher the fixed costs, the higher the break-even point.
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What is the contribution margin
ratio?
Contribution margin ratio (CMR) is the contribution amount per dollar of sales.
CM / Sales
LO 4
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LO 6MANAGERS WANT TO KNOW!
How can a company determine the effect of
taxes will be on its profits?
After tax profits = Before tax profits X (1 - tax rate)
EHD
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SUMMARY OF SIMPLIFYING CVP ASSUMPTIONS
Can separate total costs into fixed and variableCost and revenue behavior is linear. Implies
the following in the relevant rangeTotal fixed costs do not change Variable costs per unit remain constantSelling price per unit remains constant
Product mix remains constant over relevant range
LO 7
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USING ABC FOR EHD
Previously, Early Horizons Daycare used a financial model with only volume (number of children) as the cost driver. What if multiple cost drivers using the cost hierarchy are identified and used?
Previously, Early Horizons Daycare used a financial model with only volume (number of children) as the cost driver. What if multiple cost drivers using the cost hierarchy are identified and used?
LO 8EHD
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Activity Category ExampleCapacity Size limitations Building size: 30 children
Customer Needs Children transported
Product Production needs Field trips
Batch Batch A room of 5 children
Unit Variable costs Child
HIERARCHY OF COSTS: Reminder
LO 8
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COST EQUATION
LO 8EHD
Total Cost = (Unit-level cost × #children) + (Batch-level cost × # rooms) + (Product-level cost × #field trips) + (Customer-level cost × #children transported) + (Capacity-level costs × #facilities)
Continued
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EHD: ABC and Sensitivity AnalysisEHD: ABC and Sensitivity Analysis
Sales $ 12,000 $ 13,200 $ 9,000
Unit-level costs 400 440 300
Batch-level costs 2,800 3,500 2,100
Product-level costs 300 300 300
Customer-level costs 800 800 500
Facility-level costs 4,700 4,700 4,700
Operating profits $ 3,000 $ 3,480 $ 1,100
LO 8
Base CaseIncrease to 22
Decrease to 15
EHD
EX
HIB
ITE
XH
IBIT
6.86.8
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End of CHAPTER 6