Cost-Volume-Profit Analysis Quiz

Cost-Volume-Profit (CVP) Relationships

• CVP analysis examines the interrelationships between costs, volume, and profit at various activity levels.
• Break-even point (BEP) is where revenue equals expenses, and net income is zero. No profit or loss is made.
• Sales above the break-even point result in a profit; below, a loss.

Break-Even Analysis

• Break-even point (BEP) is the point where total revenue equals total costs.
• There is no gain or loss, this point has been "broken even."
• A profit or loss has not yet been made.

Cost-Volume-Profit (CVP) Analysis

• It analyzes costs and profits for various activity levels beyond just the break-even point.
• It examines the effect of changes in activity on financial results.
• Understanding how costs change with volume helps managers control costs with limited resources.
• CVP analysis is ideal for short-term decisions, like pricing policies, output levels or special orders.

Preparing CVP Analysis

• Step 1: Classify Costs

  • Fixed costs remain constant regardless of output levels.
  • Variable costs change proportionally with output levels.
  • Mixed costs have both fixed and variable components.

• Step 2: Calculate Contribution

  • Contribution is the amount available to cover fixed costs (after all variable costs are paid).
  • Contribution per unit = Selling Price – Variable Costs
  • Example: Selling Price: €40, Variable Costs: €24. Contribution = €16

• Step 3: Calculate Break-Even - a) Break-even in units: Fixed Costs / Contribution per unit. - b) Break-even in sales: Fixed Costs / Contribution per unit x Selling Price per unit.

• Other Formulas: Contribution/Sales ratio = (Contribution per unit / Sales per unit) x 100 Level of sales to result in target profit (units) = (Fixed cost + target profit) / Contribution per unit Level of sales to result in target profit (€ sales) = (Fixed cost + Target profit) x (sales price / unit) / contribution per unit

Marginal Costing Method

• An alternative method for calculating profit.
• Formula: Sales - Variable costs – Fixed costs = Net Income
• It's useful for analyzing the break-even point by highlighting the contribution of each unit sold.

Assumptions of CVP Analysis

• Selling prices are constant within the relevant range.
• Costs are linear within the relevant range and are categorized into fixed and variable components.
• In multi-product companies, the sales mix is constant.
• In manufacturing companies, inventories do not change; the number of units produced equals the number of units sold.

Weaknesses of Break-Even Analysis

• Non-linear cost relationships frequently occur in real-world scenarios.
• Costs can be "stepped" or fixed in chunks.
• Multi-product businesses often have an uneven sales mix.

Margin of Safety

• Indicates the sales volume reduction before a company incurs a loss.
• Margin of Safety (Units) = Expected sales in units – Break-even sales in units
• Margin of Safety (Amount) = Margin of safety in Units * Sale Price Per Unit
• Margin of Safety (%) = Margin of safety in Units / Expected sales in units x 100

Sensitivity Analysis

• "What if" analysis.
  • What happens if the selling price changes?
  • What happens if the costs change?
  • What happens if the sales mix changes?