PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIA

Cynthia J. Rooney, Ph.D., CPA

Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 6

Cost-Volume-Profit Analysis

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Assumptions of CVP

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- 4,000 8,000 12,000 16,000 20,000 24,000 28,000 $-

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

$80,000

Cost-Volume-Profit in Graph

Total RevenueLine

Total CostLine

Number of Coffee Drinks Served

Loss

$18,000Target Profit

Break-EvenPoint

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Basic CVP Analysis

Break-even analysis is a special case of the simplest form of cost-volume-profit analysis. The goal of break-even analysis is to determine the level of sales (in either units or total sales dollars) needed to break even, or earn zero profit.

Methods1. Profit equation method2. Unit contribution margin method3. Contribution margin ratio method

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Profit Equation Approach

(Unit price × Q) – (Unit variable costs × Q) – Total fixed costs = Profit

Q = Quantity of unit sold

Total sales revenue – Total variable costs – Total fixed costs = Profit

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To find the break-even point, we simply set the profit equation equal to zero, and solve for the

quantity of units (Q).

Break-Even Analysis(Unit Price × Q) – (Unit Variable Costs × Q) – Total Fixed Costs = Profit

($2.50 ×Q) – ($1.00 × Q) – $12,000 = 0$1.50Q = $12,000

Q = $12,000 ÷ $1.50Q = 8,000

Profit Equation Approach

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Assume that the target profit was $18,000.

Target Profit Analysis(Unit Price × Q) – (Unit Variable Costs × Q) – Total Fixed Costs = Profit

($2.50 × Q) – ($1.00 × Q) – $12,000 = $18,0001.5Q = $30,000Q = 20,000 units

Profit Equation Approach

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Unit Contribution Margin Approach

Compute the breakeven point in units for Starbucks. Recall that Starbucks’s total fixed costs are $12,000

and the unit contribution margin is $1.50 per cup.

Break-EvenUnits

Total Fixed CostsUnit Contribution Margin=

Break-Even Units

= $12,000 ÷ $1.50 per cupBreak-Even

Units= 8,000 cups

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Contribution Margin Ratio Approach

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Contribution Margin Ratio Approach

At break-even, the total contribution margin must equal total fixed costs, with nothing left over as

profit.

$12,000 ÷ 60% = Break-Even Sales ($)$20,000 = Break-Even Sales ($)

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Changes in Cost Structure

Cost structure refers to how a company uses variable costs versus fixed costs to perform its

operations. Starbucks Example:

• Investing in touch screens to allow customers to place their own order.

• Increase fixed costs by $14,000 per month.

• Decrease variable costs per unit by $0.70.

• Unit sales price will be unchanged at $2.50.

What level of volume would be needed to justify this expenditure?

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Changes in Cost Structure

Automation increases the break-even point because fixed costs are higher. But each unit adds more profit

because of the lower variable cost per unit.

Before Automation

After Automation

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Degree of Operating Leverage

Degree of operating leverage measures the extent to fixed costs are used to operate

the business. In general, high fixed costs indicate that a

company is highly leveraged.

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Multi-Product Cost-Volume-Profit Analysis

• Product mix is the relative mix of products or services stated in terms of the number of units sold.

The product mix is used to compute the weighted-average contribution margin per unit.

• Sales mix is the relative mix of products or services as a percentage of total sales revenue.

The sales mix is used to compute the weighted-average contribution margin ratio, or contribution margin as a percentage of sales.

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End of Chapter 6