Lecture 2 Cost Volume Profit Analysis Flashcards
(17 cards)
What is Cost Volume Profit (CVP) analysis?
A tool for companies to determine how changes in costs and sales volume affect a company’s profit
CVP analysis helps in understanding the relationship between costs, volume, and profit.
What is the CVP relationship formula?
profit = total revenue - total costs
This can be represented as TT = TR - TC.
What does TR stand for in the CVP analysis?
Total Revenue
TR can be calculated as P.x, where P is the selling price and x is the number of units produced and sold.
What does TC represent in the CVP analysis?
Total Costs
TC is expressed as TC = a + bx, where a is fixed cost and b is variable cost per unit produced and sold.
What is the Breakeven Point (BEP)?
The number of units output to give a profit of zero
At BEP, total revenue equals total costs (TR = TC).
How is the Breakeven Point calculated?
BEP = fixed cost / (sales revenue per unit - variable cost per unit)
This formula helps in determining how many units need to be sold to cover fixed costs.
What does the term ‘Contribution’ or ‘Contribution Margin’ refer to?
The difference between sales revenue and variable costs
It can be expressed per unit or in total.
How is the Contribution Ratio calculated?
Contribution ratio = contribution / sales revenue × 100 %
This ratio indicates the percentage of sales that contributes to fixed costs and profit.
What does Contribution Margin help business owners understand?
- Which products are most profitable
- How to optimise pricing and costs
- How much needs to be sold to cover fixed costs and achieve profitability
Understanding these aspects can lead to better decision-making.
What is the Margin of Safety?
The difference between estimated (or actual) sales and the break-even point
It indicates how much sales can drop before a loss occurs.
How is Margin of Safety measured in unit terms?
Margin of safety = budgeted (or actual) sales - break-even sales
This measure helps in assessing the risk of reaching the breakeven point.
How is Margin of Safety measured in percentage terms?
Margin of safety = (budgeted (or actual) sales - break-even sales) / budgeted (or actual) sales × 100%
This percentage indicates the safety cushion available before a loss occurs.
What does Operating Gearing (Operating Leverage) represent?
The relationship between fixed cost and variable cost
It indicates how a change in sales volume affects profit.
How is Operating Gearing calculated?
Operating gearing = fixed cost / total costs (fixed & variable)
A higher operating gearing indicates a higher level of risk.
What happens with higher Operating Gearing?
- A small change in volume causes a big change in profit (up or down)
- Indicates a higher level of risk and volatility of profits
- Higher breakeven point due to more sales needed to cover higher fixed costs
This means that businesses with high fixed costs are more sensitive to changes in sales volume.
Relationship between cost and the volume of activity
Break even chart
