cost-volume-profit analysis.ppt(managerial accounting).pptx

Cost-volume-profit (CVP) analysis is a method of cost accounting that looks at the impact that varying levels of costs and volume have on operating profit.

1. ANALYZING COST-VOLUME-PROFIT RELATIONSHIPS MANAGERIAL ACCOUNTING Chapter 5 (17th edition) Presented by: Uzair Ahmed and Iman Syeda 1

2. Cost-volume-profit analysis Defining CVP analysis and its significance in understanding the interplay between costs, volume, and profits. Exploring the key components of CVP analysis, including contribution margin and break-even point. 2

3. INTRODUCTION Cost-volume-profit(CVP) analysis helps managers to make important decisions: What services and products to offer? What prices to charge? What marketing strategy to use? What cost structure to maintain? 3

4. The Basics Of Cost Volume Profit Analysis Its primary purpose is to estimate how profits are affected by the following five factors: Selling prices Sales Volume Unit variable costs Total fixed costs and Mix of products sold 4

5. CONTRIBUTION MARGIN Contribution margin is the amount remaining from sales revenue after variable expenses have been deducted. contribution margin is used first to cover the fixed expenses, and then whatever remains goes toward profits. 5

6. A higher contribution margin ratio indicates that a larger portion of sales revenue is available to cover fixed costs and generate profit . This is crucial for businesses aiming to maximize their profitability . Interpreting Contribution Margin Ratio 6

7. Implementing strategies to reduce variable costs , increasing selling prices , and focusing on high- margin products can help improve the contribution margin ratio and ultimately drive higher profitability . Strategies to Improve Contribution Margin Ratio 7

8. CVP Relationships in Equation Form Profit = (Sales − Variable expenses) − Fixed expenses Profit = (P × Q − V × Q) − Fixed expenses It is often useful to express the simple profit equation in terms of the unit contribution margin (Unit CM) as follows: Unit CM = Selling price per unit − Variable expenses per unit = P − V Profit = (P × Q − V × Q) − Fixed expenses Profit = (P − V) × Q − Fixed expenses Profit = Unit CM × Q − Fixed expenses 8

9. CVP Relationships in Graphic Form Horizontal red line shows Total fixed expense. The blue line shows the total expense. The red line starting from zero shows the total revenue. The intersection of total revenue and total expense shows the break-even point. 9

10. Contribution Margin Ratio (CM Ratio) and the Variable Expense Ratio CM ratio = Contribution margin /sales Per unit basis: CM ratio = Unit contribution margin/unit selling price Variable expense ratio = Variable expenses /sales Per Unit basis: Variable expense ratio =Variable expense per unit/Unit selling price 10

11. The contribution margin ratio and the variable expense ratio can be mathematically related to one another: CM ratio = Contribution margin/sales
CM ratio=Sales-Variable expenses/Sales
CM ratio = 1 − Variable expense ratio 11

12. Applications of the Contribution Margin Ratio The CM ratio shows how the contribution margin will be affected by a change in sales volume. Contribution margin is expressed in equation form as: Change in contribution margin = CM ratio × Change in sales 12

13. Applications of the Contribution Margin Ratio Shows how the contribution margin will be affected by a change in sales volume. Acoustic Concepts’ CM ratio of 40% means that for each dollar increase in sales, total contribution margin will increase by 40 cents ($1 sales × CM ratio of 40%). Net operating income will also increase by 40 cents, fixed costs are not affected by the increase in unit sales. 13

14. Change in contribution margin = CM ratio × Change in sales 14

15. The relation between profit and the CM ratio Profit = (Sales − Variable expenses) − Fixed expenses Profit = Contribution margin − Fixed expenses Profit = Contribution margin × Sales − Fixed expenses Profit = CM ratio × Sales − Fixed expenses 15

16. The break-even point is where total revenue equals total costs, resulting in zero profit or loss. Understanding this point is crucial for decision-making. Unit sales to break even = Fixed expenses Unit CM Break-even analysis 16

17. Target Profit Analysis Key uses of CVP analysis we estimate the level of sales needed to achieve a desired target profit. Unit sales to attain the target profit = Target profit +Fixed expenses/unit CM 17

18. MARGIN OF SAFETY The margin of safety is the excess of budgeted or actual sales dollars over the breakeven sales dollars. It is the amount by which sales can drop before losses are incurred . The margin of safety in dollars = Total budgeted (or actual) sales− Break‐even sale 18

19. Cost Structure In Cost Structure which cost structure is better—high variable costs and low fixed costs, or the opposite? No single answer to this question is possible; each approach has its advantages . Depends on many factors, including the long-run trend in sales, year-to-year fluctuations in the level of sales, and the attitude of the owners toward risk. 19

20. Profit Stability If sales are expected to exceed $100,000 in the future, then Sterling Farm probably has the better cost structure. The reason is that its CM ratio is higher, and its profits will therefore increase more rapidly as unit sales increase, assume that each farm experiences a 10 percent increase in unit sales without any increase in fixed costs. 20

21. Sterling Farm has experienced a greater increase in net operating income due to its higher CM ratio even though the increase in unit sales was the same for both farms 21

22. Operating Leverage Operating leverage is a measure of how sensitive net operating income is to a given percentage change in unit sales. Operating leverage acts as a multiplier. If operating leverage is high, a small percentage increase in unit sales can produce a much larger percentage increase in net operating income. The degree of operating leverage is a measure, at a given level of sales, of how a percentage change in sales volume will affect profits. Degree of operating leverage = Contribution margin Net operating income 22

23. Sales Mix The term sales mix refers to the relative proportions in which a company’s products are sold. The idea is to achieve the combination, or mix, that will yield the greatest profits. A shift in the sales mix from high-margin items to low-margin items can cause total profits to decrease even though total sales may increase. 23

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25. Thanks! for your kind attention 25