Class 3 - Analysis of Cost, Volume and Price to Increase Profitability

P - unit price

V - unit variable cost

F - total fixed cost

N - volume

Learning objective:

Use the equation method to determine the break-even point.

Break-even point is when profit = $0.

Revenue-Expense = NI/NL (net income/loss)

Financial approach:

Revenue-COGS = Gross margin

Gross margin - operating expenses = NI/NL

The managerial approach:

Revenue - Total Variable Cost = Contribution Margin

Contribution Margin - fixed cost = NI/NL

P*N = revenue

V*N = Total variable cost

F = Total fixed cost

Therefore,

Total contribution margin is (P-V)*N

and

Unit contribution margin is (P-V)

Contribution Margin Ratio = (P-V)/P

Example:

Price=$10

Variable costs=$15

Fixed costs=$20,000

Contribution Margin Ratio = 10-5/10 = 5/10 = 50%

Now, what is the break-even point (break-even volume)?

$10xNBE - $5xNBE = $5xNBE

so,

$5xNBE - $20,000 = 0

and

NBE = 4,000 units

Unit fixed costs is F/N.

Up to this point, we have been using column methods.

Equation method

Sales - Total Variable cost - Fixed costs = Profit

(PxN) - (VxN) - F = $0, for break-even point

Solving for N(b-e), we get:

NBE = F / (P-V) = break-even volume

Break-even point for sales = NBE * P

Unit contribution margin = P-V

Contribution margin ration = (P-V)/P

Break even sales = NBExP = F / [(P-V)/P]

See "check yourself 3.1"

NBE = F/(P-V) = 5400/(8-2) = 900

Determining Sales Volume Necessary to Reach a Desired Profit

Sales - Total Variable Costs - Fixed Costs = Profit

PxN - VxN - F = $$

Solving for N,

N_$ = (F+$) / (P-V)

First exam is on chapters 1-3, which we've just about covered now.

Assessing the Price Strategy

See book page 112

Assessing the Effects of Changes in Variable Costs

Cost-Volume-Profit Graph

See pg 116.

Plot $ vs. units

Draw lines for Fixed cost (horizontal), total sales (high slope), total cost (low slope)