Lesson-(Script).docx

Hello and welcome to this session in which we would look at cost volume profit analysis for short known as CVP. What is cost volume profit analysis? Simply put, it\'s a tool. It\'s a tool to do what? It\'s a tool to help managers make business decision. Now, how do we use this tool? Well, you have t...

Hello and welcome to this session in which we would look at cost volume profit analysis for short known as CVP. What is cost volume profit analysis? Simply put, it\'s a tool. It\'s a tool to do what? It\'s a tool to help managers make business decision. Now, how do we use this tool? Well, you have to understand what is cost volume profit analysis. The best way to understand it is to break down the components of this formula, cost, volume, profit, and see what each one means and see how it\'s all put together. Starting with the cost, what is cost? What do we know about cost? Well, we have two type of cost. We need to understand that we have variable cost, cost that varies with the production, with the selling of each item. Each additional unit will incur this cost. So it varies with sales. It varies with production. An example of it. If you\'re a manufacturer in a car, every car need four tires. So every car you produce, you need at least four tires, at least four tires. So it varies. The tires are a variable cost in terms of car production. Fixed cost is a cost that does not change with production. So if you, if we\'re again, if we\'re discussing the car manufacturing Ford motor company, Well, in one manufacturing plan, they might produce 100 cars or 500 cars. It does not matter. The depreciation of the equipment does not really matter because it\'s a fixed cost. If they are renting a warehouse to produce those cars, the rental cost does not change. It\'s a fixed cost. So it doesn\'t vary with the production. And the assumption here is, you know, what variable costs and fixed costs. In this session sometime I would refer to them as variable expenses and fixed expenses. It doesn\'t matter whether I used cost or expense. It\'s the same thing. So this is what cost is volume. What is a volume? Volume deals with quantity, quantity of units sold or produce. Okay. So we need to understand what is a quantity. Well, The quantity is if you sold 100 unit, well, that\'s the quantity of the unit, 100 unit. And if you produce 100 unit, that\'s the quantity, 100 unit. So there\'s a relationship between cost, volume, and profit. And what we\'re saying here, volume do matter, especially when we are dealing with variable costs. Remember, variable cost varies with the number of unit produced. or the number of units sold. So that\'s why quantity is important. The third component is profit. What is profit? Now let\'s think about profit. How do we make a profit? Well, let\'s, let\'s think about it for a moment. We sell something, we sell something, we have sales, then we have to deduct from the sales, the cost. Well, remember what is cost cost. We have variable cost or variable expense and fixed cost. Once we take the sale, deduct our cost. We should come up with our profit or net operating profit. Simply put, we\'re going to take sales and what is sales? Now let\'s break down sales. How do you know what sales is? Sales is the selling price, whatever you\'re selling, that unit prices times the quantity sold. How many units you sold? times the price gives you sales. From the sales, you are going to deduct your variable cost. What is variable cost? What\'s it\'s your variable cost per unit times how many quantity you sold. So Q is the same. So if you sold 10 units, well, you sold 10 units, the variable cost of 10 units will need to be expensed or cost. Then, so we have Then after we deduct variable cost, we deduct fixed cost and we come up with our profit. And this is what I showed you right here. Sales minus variable cost minus fixed cost equal to your profit. Now, here\'s what you need to know. A term you need to know, selling, selling price minus variable cost. equal to something called contribution margin. So selling price. So if you\'re selling something for 10, it has a variable cost of four, we would say 10 minus four equal to six. We say the six is the contribution margin per unit. Now, if you\'re selling 100 units, you multiply this by 100, you multiply this by 100 and the contribution margin will change. But nevertheless, it\'s the same concept. That\'s the contribution margin. So six is the contribution margin per unit. Now from the six, you deduct your fixed cost. Let\'s assume fixed cost is two, yield profit is 4. Now we can simplify this formula a little bit further. Why? Because if you notice from a mathematical perspective, if this sales minus variable cost equal to the contribution margin, and Q is an element common to both. What we can say, we can say that. And by the way, we can, before we simplify, this is the contribution margin income statement. So we did this in a prior session. So hopefully you are familiar with this formula. Nevertheless, I just explained it. So here\'s what I do. I can. I can simplify this formula and I can say profit equal to, if this is the contribution margin. So it\'s the contribution margin times the quantity minus fixed costs. So this is the same as this, just the, just simplified. Now, what I want you to do is to jot this formula down. I\'m going to show you how to solve problems with this formula later on. Later on means in few minutes when I work. A problem. So we need to look at a actual problem for this to make sense to actually work an example. So we\'re going to be looking at Adam Electronics retailer. Adam sells tablets. That\'s what that\'s what he does. And this is the margin contribution margin income statement for the month of December. Adam sells for that for that month, 500 unit. 500 tablets and this, and the selling price per unit is 500. The same. Well, what does sales equal to? Well, quantity times selling price will give us 250, 000. Now Adam will need to account for variable cost. Well, variable cost is 300 per unit. We sold 300 times. The quantity is 500, same as quantity above the variable cost or the variable expense. Notice if I said cost or expense, they mean the same thing. Your textbook or your CPA review course might use either expense or cost. So it\'s the same thing. Now, when we take sales minus variable costs, remember selling price minus contribution margin sales, whether it\'s times quantity or not, it doesn\'t really make a difference. Okay. That\'s going to give us contribution margin. So this is the total contribution margin for this company for the month of December, and this is the contribution margin per one unit. So each unit. that Adam sells, he\'ll have a contribution margin of 200. Now from the contribution margin, the company will deduct their fixed expenses. What are fixed expenses? Uh, rent expense, tax expense, uh, insurance, utility, so on and so forth. So they will deduct their fixed expenses. And from their fixed expenses, we come up with net operating income. Again, This is the contribution margin income statement that you need to be familiar with. But here we need to focus a little bit more on the concept of contribution margin, because that\'s very important. Contribution margin is needed for Adam. Why is the contribution margin is needed to cover, to cover his fixed expenses. Otherwise he would not have any profit. So Adam will need to have at least 80, 000 of contribution margin. will not have a profit. Why 80, 000? Because the fixed expenses are 80, 000. Give me 80, 000 or I\'m going to be not profitable. Okay. So the contribution margin per unit is 200. So it\'s very important to understand what does this 200 means. So I\'m going to have to explain it to you. Think about a bucket. So we have a bucket. So I\'m going to just going to draw a bucket. I\'m not really good at drawing, but you guys will get the point. So this is a bucket and this bucket is called fixed cost bucket, fixed cost or fixed expenses. And this bucket is 80, 000 needs 80, 000. What does that mean? It means before Adam makes a profit, and this is the profit bucket. This is the profit bucket. This is the profit before Adam starts to make a profit. You simply put, let\'s assume there\'s a basically. Once this is filled, it will go to the profit. So what does that mean? It means for every unit we sell, we put here 200, 200, 200, 200. We keep on this 200. We\'ll keep on going toward the fixed cost until the fixed cost is. The fixed cost bucket is full. Once the fixed cost bucket is full. If we add 200, it\'s going to go to the profit bucket because the fixed cost has been filled. So that\'s why it\'s very important to understand the role of the contribution margin per unit. Now we can now compute how many 200 do we need per unit. To fill out the bucket, how many, how many do we need to fill out the bucket to complete our fixed costs? Well simply put, if we need, if we know our fixed cost is 80,000, 80,000 divided by \$200, which is the contribution margin per unit, what does that mean? It tells us we need 400 tablets. Once we sell 400 tablets, if this is empty once we sell, so 200 times 400. Whoops. Let me go back to the end. Row the bucket. Okay. So once we sell 400 buckets of 400 tablets, the bucket of fixed costs is filled and every additional unit we sell, it\'s going to put the 200 in the profit bucket. So this is the importance of it. So let me show you exactly what does it look like from a contribution margin income statement. Assuming we sell 400 units, we sell 400 units for a 400 units times 500. Our sales is 200, 000 variable expenses, 300. Dollar per unit times 400 unit, 120, 000. Our contribution margin is 80 and voila, fixed expense is 80. We don\'t make any profit. So at this point, what\'s what happened is this, that fixed cost bucket is filled. We fill out that fixed cost bucket. So if we sold 400 unit, I showed you, we\'ll, we\'ll, we\'ll fill it. So this is called also the break even point, which is profit equal to zero. And when does the profit equal to zero, we\'ll talk about the break even in a separate recording is when the contribution margin equal to the fixed cost. We make a profit of 200 because well, once the 200 gets here, it doesn\'t, it doesn\'t fit in this bucket anymore. So it\'s going to go to the profit bucket. So the 200 will go here, and this is what we mean by for each, each additional unit. Now we, if we want to know how much profit would Adam make if he sells 440, 000 tablets, it\'s easy. We\'ll take 40. 40 units. Why 40? Because 400 is for the fixed cost. The additional 40 is the profit. So the 40 times 200 per unit will give us 8,000. No need for the contribution margin income statement, however, I\'m gonna use the formula that I showed you earlier that we computed. We set profit equal to the contribution margin times quantity minus fixed cost. Well, 8,000 in profit, so this is equal to 88,000. If we take 440 units. So it\'s very important to be familiar with them. One is this. Selling price does not change with volume. And this is not really true in the real world. What does that mean? So those are simplifying assumptions so we can understand this, this process. What does that mean? Sometime when you sell more, If you have a demand for your product, you might increase the price here. We\'re assuming the price does not change. The opposite is true. If you don\'t have enough demand, you might lower the price. We don\'t assume this. We assume that all costs are strictly either variable and fixed. And that\'s not also true in the real world. And we talked about this when we talked about how costs behave, variable versus fixed. For our purposes, we keep it simple. It\'s either variable, 100 percent variable or 100 percent fixed. And we assume later on when we do multi product company sales, when we have more than one, 100 product selling, we assume the sales mix is constant. So if we have two, three product, product A and product B, we assume we\'re selling, for example, 30 percent of product A and 70 percent of product B for the sales mix. And that\'s not really true also in the real world, but in the real world, the software Excel sheet algorithm will make adjustments at the end of this recording.