Unit 5: Cost-Volume-Profit Analysis
In this unit we explore the relationships that revolve around costs, volume, and profit (CVP), and how companies plan for profitability. We examine how business managers use costs, volume, and profit to calculate how much they need to produce to achieve the break-even point and generate future profits. For example, a chief executive officer of a company that manufactures snowboards should know how many boards they need to produce to cover their costs and earn a decent profit by the end the month.
Breakeven analysis is synonymous with CVP analysis and identifies how changes in key variables impact financial projections and profitability.
Completing this unit should take you approximately 5 hours.
Upon successful completion of this unit, you will be able to:
- perform cost-volume-profit analysis for single-product and multiple-product companies;
- perform sensitivity analysis using the cost-volume-profit model;
- use an alternative form of contribution margins, such as contribution margin per unit of constraint, when faced with resource constraints;
- demonstrate the effect of income taxes on the cost-volume-profit model; and
- discuss the effects of absorption and variable costing on profits.
5.1: Cost-Volume-Profit Analysis
Read the Chapter 6 introduction, and then click on "Next Section" to read Section 6.1. In this unit, Snowboard Company uses CVP analysis to determine its break-even point and what additional volumes it would need to sell to achieve a decent profit. CVP assumes that the selling price per unit is the same throughout the relevant range. Cost-volume-profit analysis involves finding the break-even point and target profit point in units and in sales dollars. The key formulas for an organization with a single product are developed and explained in the reading.
Read section 6.2. By expanding the equation taught in Section 1, a company who manufactures more than one product can still determine their break-even point with the same basic variables.
5.2: Using Cost-Volume-Profit Models for Analysis
Seldom are financial predictions exactly correct; there is a natural variance in predictions. As a result of this natural variance, managers should always be aware of how sensitive their predictions are to fluctuations in the model’s variables. Sensitivity analysis shows how the cost-volume-profit model will change with changes in any of its variables. Although the focus is typically on how changes in variables affect profit, accountants often analyze the impact of uncertainty on the break-even point and target profit as well. Read section 6.3. to learn more.
Read section 6.4, which explores the effects that various loads of fixed costs have on CVP analysis. The amount of fixed costs (cost structure) that a company carries is often established by the type of industry it operates in. The cost structure of a firm describes the proportion of fixed and variable costs to total costs. Operating leverage refers to the level of fixed costs within an organization. The term "high operating leverage" is used to describe companies with relatively high fixed costs. Firms with high operating leverage tend to profit more from increasing sales, and lose more from decreasing sales, than a similar firm with low operating leverage
5.3: Cost-Volume-Profit Considerations
In section 6.5, you will examine the case of Kayaks-For-Fun, which has limited amounts of labor. How do they manage those constrained units of labor to maximize profits? Many organizations operate with limited resources in areas such as labor hours, machine hours, facilities, or materials. The contribution margin per unit of constraint is a helpful measure in determining how constrained resources should be allocated.
The target profit for a company required to pay income taxes should consider the effect of those taxes on their analysis. Step 1 requires the calculation of a new after-tax target amount. Step 2 converts the after-tax profit to a before-tax target amount. Finally, step 3 calculates the target profit in dollars or units for the desired profit calculated in step 2. Learn more about these 3 steps in Section 6.6.
The accounting treatment for variable and fixed costs is slightly different with a variable costing approach. Only the overhead account receives different treatment as the overhead costs are divided into fixed costs and variable costs. Read Section 6.7 to learn a new approach for recording those costs. Note that the end of chapter exercises are optional.