Chapter 12 - Financial and Cost-Volume
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Transcript Chapter 12 - Financial and Cost-Volume
Financial and
Cost-Volume-Profit Models
Chapter 12
Financial Modeling
Quantitative simulation of relations among
various factors
Allows the organization to assess “what if”
scenarios to support
Decision making
Forecasting
Cost-Volume-Profit Models
Illustrates the relationship between sales
volume, costs and revenues
Based on variable (direct) costing
Sales – variable costs = contribution margin
Each additional unit sold “contributes” that amount
to the bottom line
Breakeven point is reached when total
contribution equals total fixed costs
Cost-Volume-Profit Models
Basic formula
Fixed cost + desired profit
Unit sales =
Contribution margin per unit
Breakeven point occurs at a profit of zero
Cost-Volume-Profit Models
Example
Sales price = $100
Variable cost per unit = $40
Total fixed cost = $36,000
$36,000 + 0
= 600 units
$60/unit
$160,000
$140,000
$120,000
Breakeven
point
$100,000
$80,000
$60,000
Variable cost
$40,000
$20,000
Unit sales
Fixed cost
Total cost
Revenue
00
1,6
00
1,5
00
1,4
00
1,3
0
80
00
0
70
1,2
0
60
00
0
50
1,1
0
40
0
00
0
30
1,0
0
20
90
0
10
$0
0
Revenue and costs
$180,000
Cost-Volume-Profit Models
Income tax effect
“Desired profit” in basic model assumes no
income taxes
Obviously, more units must be sold if taxes must
be paid on the profits
Adjustment to basic model
Fixed cost + Profit / (1 – tax rate)
Unit sales =
Contribution margin per unit
Cost-Volume-Profit Models
Same example
Desired profit = $24,000
Basic model
$36,000 + 24,000
= 1,000 units
$60/unit
If tax rate is 20%
$36,000 + 24,000/(1 - .20)
$60/unit
= 1,100 units
Cost-Volume-Profit Models
Contribution margin can be used to make
scarce resource allocation decisions
Goal is to maximize the amount of income
that can be generated
How to best use the scarce resource?
Determine the contribution per unit of the
scarce resource
Can only consider one resource at a time
Sales price
Variable cost/unit
Contribution margin
Units of scarce
resources required for
each unit of product
Contribution margin per
unit of scarce resource
Product A Product B Product C Product D
$
100 $
210 $
380 $
450
72
90
200
210
$
28 $
120 $
180 $
240
2
$
14
5
$
24
6
$
What is the best use of 300 units of the resource?
30
12
$
20
Cost-Volume-Profit Models
Multiple product situations
Basic model assumes only one product
Multiple product situation replaces the
contribution margin per unit with the weighted
average contribution margin
Based on the normal relative sales volumes of the
products
Resulting “units to sell” is then divided among
the products in their original proportions
Cost-Volume-Profit Models
Example
Selling
Product
price
Folders
$ 1.00
Binders
5.00
Portfolios
20.00
Var.cost
per unit
$ 0.40
2.20
12.00
CM per
unit
$ 0.60
2.80
8.00
Relative Weighted
sales
CM per unit
60% $
0.36
30%
0.84
10%
0.80
$
2.00
Fixed cost
$ 100,000
Desired profit
$
10,000
Cost-Volume-Profit Models
$100,000 + 10,000
= 55,000 units
$2.00/unit
Product
Folders
Binders
Portfolios
Relative
sales
60%
30%
10%
Total
sales
55,000
55,000
55,000
Units of
product
33,000
16,500
5,500
CM per
unit
$ 0.60
2.80
8.00
Total CM
$ 19,800
46,200
44,000
$ 110,000
Cost-Volume-Profit Models
Operating leverage
Companies with relatively low variable costs
per unit, but high fixed costs, experience
greater swings in profitability with volume
changes than do companies with high
variable costs and low fixed costs
Operating leverage is a multiplier
%∆ in sales * operating leverage = %∆ in income
Cost-Volume-Profit Models
Contribution margin
Operating leverage = Operating income
Sales
Variable costs
Contribution margin
Fixed costs
Operating income
Company A
$ 1,000,000
300,000
$
700,000
600,000
$
100,000
Company B
$ 1,000,000
600,000
$
400,000
300,000
$
100,000
Operating leverage
7.00
4.00
Cost-Volume-Profit Models
A 10% increase in sales will result in a
70% increase in Company A’s income, but
only a 40% increase in Company B’s
Sales
Variable costs
Contribution margin
Fixed costs
Operating income
New operating leverage
Company A
$ 1,100,000
330,000
$
770,000
600,000
$
170,000
Company B
$ 1,100,000
660,000
$
440,000
300,000
$
140,000
4.53
3.14
Multiple Driver Models
CVP model assumes all costs are either
variable and driven by sales, or fixed
In reality, costs and revenues have many
different drivers
ABC-based model should be more
accurate
Considers the major drivers of costs
Sensitivity Analysis
Model inputs are estimates, actual results
may vary considerably
Sensitivity analysis plays “what if” with the
inputs
Changes in volume of cost and revenue
drivers
How much will the income be affected by
other scenarios?
Theory of Constraints
Identification and best use of bottlenecks
Bottleneck is anything that prevents the
company from producing and selling more
Process: machine capacity, available labor
Policy: no weekend or overtime work
Resource: shortage of materials
Market: not enough demand for product
Theory of Constraints
Product A
Product B
Product C
Process 1
Capacity:
12/hour
Process 2
Capacity:
4/hour
Process 3
Capacity:
6/hour
Process 4
Capacity:
5/hour
Theory of Constraints
Step 1: Identify appropriate value measure
Usually throughput
Step 2: Identify bottlenecks
Work piling up, unused capacity, etc.
Step 3: Optimize the bottleneck
What will produce the greatest value?
Theory of Constraints
Step 4: Adjust process to bottleneck’s needs
Produce only what is needed by the bottleneck
Step 5: Alleviate the bottleneck
Add capacity, demand, etc.
Step 6: Repeat steps 1-5
Eliminating one bottleneck creates another
Product A Product B Product C
Throughput
per unit
Daily demand
Minutes req'd
per unit
Process 1
Process 2
Process 3
Process 4
Throughput
per minute of
Process 2
Produce
Process 2
minutes used
$
28
14
$
5
10
3
7
$
2.80
6
60
$
120
10
$
180
15
8
15
6
8
15
18
5
9
8.00
10
$ 10.00
15
150
270
Total minutes
required
375
560
177
313
Total used
480