CVP ANALYSIS

COST VOLUME PROFIT (CVP) GRAPH

 ✓ All costs are either variable or fixed
✓ Total cost and total revenues are predictable and linear

✓ Fixed cost remain constant

✓ Unit variable cost remain constant

✓ Unit selling price remain constant

✓ FG and WIP inventories do not change significantly
✓ Time value of money is ignored
✓ Margin of Safety (MOS) and MOS Ratio

✓ Degree of Operating Leverage (DOL)

✓ Contribution Margin (CM)

✓ CM per unit (CMu) and CM Ratio (CMr)

✓ Breakeven in units (X) or sales

✓ Sales Mix
 Operating Leverage
Operating leverage is a measure of how sensitive net operating income
is to percentage changes in sales. It is a measure, at any given level of
sales, of how a percentage change in sales volume will affect profits.

Degree of Contribution margin

operating leverage = Net operating income
 Learning Objective 4

Show the effects on net operating

income of changes in variable costs,
fixed costs, selling price, and sales
volume.
 Additional Applications of CVP Concepts – Example 1
Example 1: Change in Fixed Cost and Sales Volume
What is the profit impact if RBC can increase unit sales from 500
to 540 by increasing the monthly advertising budget by
$10,000?
Additional Applications of CVP Concepts – Solution to Example 1
Example 1: Change in Fixed Cost and Sales Volume
$80,000 + $10,000 advertising = $90,000
500 units 540 units
Sales $ 250,000 $ 270,000
Less: Variable expenses 150,000 162,000
Contribution margin 100,000 108,000
Less: Fixed expenses 80,000 90,000
Net operating income $ 20,000 $ 18,000

Sales increased by $20,000, but net operating income decreased by $2,000.

 Additional Applications of CVP Concepts – A Shortcut
Example 1: Change in Fixed Cost and Sales Volume
A shortcut solution using incremental analysis

Increase in CM (40 units X $200) $ 8,000

Increase in advertising expenses 10,000
Decrease in net operating income $ (2,000)
Additional Applications of CVP Concepts – Example 2
Example 2: Change in Variable Costs and Sales Volume

What is the profit impact if RBC can use higher quality

raw materials, thus increasing variable costs per unit
by $10, to generate an increase in unit sales from 500
to 580?
Additional Applications of CVP Concepts – Solution to Example 2
Example 2: Change in Variable Costs and Sales Volume
580 units × $310 variable cost/unit = $179,800
500 units 580 units
Sales $ 250,000 $ 290,000
Less: Variable expenses 150,000 179,800
Contribution margin 100,000 110,200
Less: Fixed expenses 80,000 80,000
Net operating income $ 20,000 $ 30,200

Sales increase by $40,000 and net operating income increases by $10,200.

 Additional Applications of CVP Concepts – Example 3
Example 3: Change in Fixed Cost, Selling Price, and Sales Volume

What is the profit impact if RBC:

1. cuts its selling price $20 per unit,
2. increases its advertising budget by $15,000 per month, and
3. increases sales from 500 to 650 units per month?
Additional Applications of CVP Concepts – Solution to Example 3
Example 3: Change in Fixed Cost, Selling Price, and Sales Volume
650 units × $480 = $312,000
500 units 650 units
Sales $ 250,000 $ 312,000
Less: Variable expenses 150,000 195,000
Contribution margin 100,000 117,000
Less: Fixed expenses 80,000 95,000
Net operating income $ 20,000 $ 22,000

Sales increase by $62,000, fixed costs increase by $15,000, and net operating income
increases by $2,000.
 Additional Applications of CVP Concepts – Example 4
Example 4: Change in Variable Cost, Fixed Cost, and Sales Volume

What is the profit impact if RBC:

1. pays a $15 sales commission per bike sold instead of paying
salespersons flat salaries that currently total $6,000 per month,
and
2. increases unit sales from 500 to 575 bikes?
Additional Applications of CVP Concepts – Solution to Example 4
Example4: Change in Variable Cost, Fixed Cost, and Sales Volume
575 units × $315 = $181,125

500 units 575 units

Sales $ 250,000 $ 287,500
Less: Variable expenses 150,000 181,125
Contribution margin 100,000 106,375
Less: Fixed expenses 80,000 74,000
Net operating income $ 20,000 $ 32,375

Sales increase by $37,500, fixed expenses decrease by $6,000, and net operating
income increases by $12,375.
 Additional Applications of CVP Concepts – Example 5
Example 5: Change in Selling Price

If RBC has an opportunity to sell 150 bikes to a wholesaler

without disturbing sales to other customers or fixed expenses,
what price would it quote to the wholesaler if it wants to
increase monthly profits by $3,000?
Additional Applications of CVP Concepts – Solution to Example 5
Example 5: Change in Selling Price

$ 3,000 ÷ 150 bikes = $ 20 per bike

Variable cost per bike = 300 per bike
Selling price required = $ 320 per bike

150 bikes × $320 per bike = $ 48,000

Total variable costs = 45,000
Increase in net operating income = $ 3,000
 Structuring Sales Commissions
Companies generally compensate salespeople by paying them
either a commission based on sales or a salary plus a sales
commission. Commissions based on sales dollars can lead to
lower profits in a company.

Let’s look at an example.

 Structuring Sales Commissions – Example
Pipeline Unlimited produces two types of surfboards, the XR7 and the Turbo.
The XR7 sells for P1,000 and generates a contribution margin per unit of
P250. The Turbo sells for P1,500 and earns a contribution margin per unit of
P180.

The sales force at Pipeline Unlimited is compensated based on sales

commissions.
 Structuring Sales Commissions – Solution
If you were on the sales force at Pipeline, you would push hard to
sell the Turbo even though the XR7 earns a higher contribution
margin per unit.

To eliminate this type of conflict, commissions can be based on

contribution margin rather than on selling price alone.
2.The margin of safety in the Versace Company is P24,000. If the
company's sales are P120,000 and its variable expenses are
P80,000, its fixed expenses must be _____________
3.Holt Company's variable expenses are 70% of sales. At a
P300,000 sales level, the degree of operating leverage is 10. If
sales increase by P60,000, the degree of operating leverage will
be ________.
8.A company makes a single product that it sells for P16 per unit.
Fixed costs are P76,800 per month and the product has a
contribution margin ratio of 40%. If the company's actual sales are
P224,000, its margin of safety is: ______________
E.D. Manufacturing, Inc. produces and sells ice skates. The current
net operating income is P40,000, with a degree of operating
leverage of 3. If sales increase by 10%, how much total net
operating income should be expected? ________________
 Breakeven Analysis When More Than One Product
The total sales in units of a company are made up of 40% of Product A
and 60% of Product B. The selling prices are P4 and P3 for A and B,
respectively. Unit variable cost for A is P2.50 while for B, it is P1.75. Fixed
costs for the company are P67,500. How many units of Product B must be sold
to breakeven?
 Breakeven Analysis When More Than One Product
A company’s sales mix consists of a composite unit of 25 units of Product A, 5
units of Product B and 20 units of Product C. The company fixed costs are
P492,000. Unit selling price and unit variable costs are as follows: P10 and
P5 for A, P6 and P4 for B and P8 and P4.50 for C. How many units of
Product C must be sold to breakeven?