Cost Volume-Profit Analysis, Break Even.pptx

it gives the explanation of different types of costs. Explains the term profit and shows how in a business the costs impact profit. It also brings out the Break-even point and its significance in business decision making

1. Costs, Cost-Volume-Profit Analysis Break-Even analysis Dr. Nandita Sethi

2. Basic Cost Terms and Concepts Cost Terms - Fixed - Variable Cost Concepts Management Implications

3. The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk Costs are Irrelevant

4. Short-Run Cost Functions Total Cost = TC = f(Q ) Total Fixed Cost = TFC Total Variable Cost = TVC TC = TFC + TVC

5. Short-Run Cost Functions Average Total Cost = ATC = TC/Q Average Fixed Cost = AFC = TFC/Q Average Variable Cost = AVC = TVC/Q ATC = AFC + AVC Marginal Cost =  TC/  Q =  TVC/  Q

6. Economic Costs Total Cost = TFC +TVC Total Fixed Cost = K Total Variable cost = f (Q) Average Cost = TC/Q = AFC + AVC (Unit cost) Average Fixed Cost = TFC/Q Average Variable Cost = TVC /Q Marginal Cost = TCn – TC n-1 OR = ẟTC/ ẟQ

7. Cost Terms Fixed Costs: costs that remain constant regardless of the quantity of product produced. Variable Costs: costs that increase linearly and proportionately as production volume increases. Profit = (Sales Revenue-Variable Cost) - Fixed Cost Total Contribution Margin

8. Case Study- Furnico Chair Mgf. Collapsing Profits on collapsible chairs

9. Cost Terms (Continued) Cost Driver: Manufacturing Cost: Sales and General Administrative Costs: Direct and Indirect Costs: Controllable and Uncontrollable Costs: Product/Period Cost: Any activity or event that causes costs to be incurred. Direct material (DM), direct labor (DL), and manufacturing overhead (MOH). All costs associated with running the business, excluding production costs. Costs that can either be traced (direct) or not traced (indirect) to a specific department in the organization. Costs used to describe the extent of a manager ’ s influence on cost. Refers to the timing which costs become expenses.

10. Economic Terms Opportunity Cost: Sunk Cost: Differential and Incremental Cost: Marginal Cost: Historical vs Replac- ment Cost Average Cost per Unit: Benefit lost because the choice of one action precludes another action. Costs that have already been incurred and can not be altered by current or future decisions. Difference in the costs incurred under two alternative actions. Cost associated with producing one additional unit. Cost at the time of purchase vs the current cost of acquiring a resource Total cost for the quantity produced, divided by the number of units produced.

11. Bala ’ s Bare Bones Manufacturing Facility Raw Materials Direct Material Storage It ’ s a Warehouse! Direct Material Used Direct Material Purchased Direct Material WIP Manufacturing Overhead Costs Finished Goods Inventory

12. Cost Concept Direct Material Inventory Beginning Transfer to Inventory WIP $1,000 $78,000 Purchases $79,000 Ending Inventory $2,000 Work in Process Inventory Beginning Transfer to Inventory Finished $40,000 Goods Inventory Direct $350,000 Material $78,000 Direct Labor $82,000 MOH Incurred $170,000 Ending Inventory $20,000 Finished Goods Inventory Beginning Cost of Inventory Goods Sold $1,000 (shipped) $340,000 Goods Completed From WIP $350,000 Ending Inventory $11,000

13. Allocation of Costs Storeroom Factory Warehouse Direct Material Purchased (DMP) Raw Material Inventory Direct Material Used (DMU) Direct Labor (DL) Manufacturing Overhead (MOH) Cost of Goods Manufactured (COM) WIP Inventory Finished Goods Inventory Cost of Goods Sold (COGS)

14. Break Even Example Fixed costs = $600000 Sale price of tennis racquet = $200 Variable cost of each tennis racquet = $80 BE= Total fixed costs Sales Price – Variable costs per unit BE = 600000 (200-80) = 600000 120 Break Even = 5000 units

15. What does it mean for ‘Better Racquets’? 5000 racquets need to be sold in one year to break even That means above a 100 racquets need to be sold every week to break even. If the business sells less than 100 racquets/week then ‘Better racquets’ has made a loss. If the business sells more than 100 racquets/week then ‘Better racquets has made a profit.

16. A graphical example By using a cost volume graph it illustrates when a profit or loss is expected.

17. Break Even Graph Dissected Fixed Costs Variable Costs

18. Total Costs Total costs = Fixed costs + variable costs The Total Costs curve begins at 0 sales and Fixed costs.

19. Break Even Analysis A worked example Sales Price = $1000 Variable cost per unit = $800 Fixed costs = $30000

20. Break Even Analysis A worked example Sales Price = $1000 Variable cost per unit = $800 Fixed costs = $30000 BE= Total fixed costs Sales Price – Variable costs per unit BE = 30000 (1000-800) = 30000 200 Break Even = 150 units

21. Units Fixed Costs Variable costs Total costs Revenue Profit 30000 30000 -30000 25 30000 20000 50000 25000 -25000 50 30000 40000 70000 50000 -20000 75 30000 60000 90000 75000 -15000 100 30000 80000 110000 100000 -10000 125 30000 100000 130000 125000 -5000 150 30000 120000 150000 150000 175 30000 140000 170000 175000 5000 200 30000 160000 190000 200000 10000 225 30000 180000 210000 225000 15000 The Excel Spread Sheet Table

22. DOL at Q units of output (or sales) Degree of Operating Leverage – The percentage change in a firm ’ s operating profit (EBIT) resulting from a 1 percent change in output (sales). = Percentage change in operating profit (EBIT) Percentage change in output (or sales) Degree of Operating Leverage (DOL)

23. DOL Q units Calculating the DOL for a single product or a single-product firm. = Q ( P – V ) Q ( P – V ) – FC = Q Q – Q BE Computing the DOL

24. DOL S dollars of sales Calculating the DOL for a multiproduct firm. = S – VC S – VC – FC = EBIT + FC EBIT Computing the DOL