Basic_Cvp_Analysis

Basic CVP Analysis 1. Using the equation method, we know: Profit = Unit CM X Q – Fixed Expense $ 0 = ($30-$18) X Q - $150,000 $ 0 = $12 X Q - $150,000 $12Q = $150,000 Q = $150,000 / 12 = 12,500 12,500 pairs X $30 per pair = $375,000 The break-even point is the level of sales at which profit is zero. It provides a company with valuable information regarding how much sales revenue is required to cover its operating costs, thus can give an understanding of how aggressively the company must market its products to meet its operating costs. [pic] 2. CVP Graph [pic] 3. Sales (12,000 pairs of shoes X $30.00 per pair) $ 360,000 Variable Expenses (12,000 pairs X $18.00 per pair) 216,000 Contribution Margin (CM) 144,000 Fixed Expenses 150,000 Loss ($6,000) If 12,000 pairs of shoes are sold in a year, Shop 48’s loss would be $6,000. [pic] 4. If the company is considering paying the store manager of Shop 48 an incentive commission of 75 cents per pair of shoes (in addition to the sales person’s commission), the total variable expenses per pair of shoes will be $18.75 ($18.00 + $0.75). As a result, CM will be ($30.00- $18.75) $11.25 per pair. Profit = Unit CM X Q – Fixed expenses $0 = ($30.00 - $18.75) X Q - $150,000 $0 = ($11.25) X Q -$150,000 $11.25Q = $150,000 Q = $150,000/ 11.25 Q = 13,333 pairs (rounded); 13,333 pairs X $30.00 per pair = $399,990 If the change is made, the new break-even point in dollar sales is approximately $400,000 and in unit sales 13,333 pairs of shoes. [pic] 5. Sales (15,000 pairs X $30.00 per pair) $ 450,000 Variable Expenses (12,500 pairs X $18.00 per pair; 2,500 pairs X $18.50 per pair) 271,250 Contribution Margin 178,750 Fixed Expenses 150,000 Net Operating Income $ 28,750 If the company is considering paying the store manager 50 cents commission for each pair of shoes sold in excess of the break-even point, the shop‘s net operating income is $28,750. 6. Profit = Unit CM X Q – Fixed expenses $0 = ($30,000 - $13.50) X Q - $181,500 $0 = ($16.50) X Q = $181,500 $16.50Q = $181,500 Q = $181,500 / $16.50 Q = 11,000 pairs 11,000 pairs X $30.00 per pair = $330,000 in sales. If the company eliminates sales commissions entirely in its shops and increases fixed salaries by $31,500 annually, the new break-even point in dollar sales is $330,000 and 11,000 in unit sales for Shop 48. By doing so, the contribution margin is increased and the break-even point is decreased, thus leading to a better margin of safety (‘’excess of budgeted or actual sales dollars over the break-even volume of sales dollars’’, Noreen, Brewer & Garrison, 2011, p.135), which is good for the company. However, this scenario would change the cost structure (higher fixed expenses). As a general rule, higher fixed costs and lower variable costs affect more net operating – as sales fluctuate with greater profits in good years and greater losses in bad years. Furthermore, sales personnel may find the ‘’new rule’’ not as advantageous as before since their salaries would be the same- no matter how many pair of shoes are sold. Consequently, manager also needs to take into account these different components. Reference Noreen, E. W., Brewer, P. C., &Garrison, R. H. (2011). Managerial accounting for managers (2nd Ed). New-York, NY: McGraw-Hill ----------------------- Breaking point at 12,500 pairs of shoes and at $375,000 dollar sales