Basic CVP Analysis Sarah Morris BUS630 Mark Taylor January 31, 2011

Analysis Basic CVP Analysis Before completing this assignment, one must understand the purpose of cost volume profit analysis (CVP analysis). CVP analysis helps managers to understand the interrelationship between cost, volume, and profit in an organization (Cost Volume Profit Relationship, 2011). It focuses on the interactions among the following five elements (Cost Volume Profit Relationship, 2011):

1. Prices of products 2. Volume or level of activity 3. Per unit variable cost 4. Total fixed cost 5. Mix of product sold

A manager can use CVP analysis as a guide for pricing, marketing, and manufacturing strategies. This paper will discuss the required questions a-f based on the following given information for The Fashion Shoe Company:
Per Shoe $30 $13.50 4.50 $18.00

Selling Price Variable expense Invoice cost Sales commission Total Variable Cost Annual Fixed Expense Advertising Rent Salaries Total fixed cost

$30,000 20,000 100,000 $150,000

Section A

Analysis Section A of this assignment requires the calculation of the annual break-even point in

dollar sales and in unit sales for Shop 48. The break-even occurs at the level of sales where profit is equal to zero. This allows a manager to determine how far sales could drop before the company begins to lose money. For Shop 48 of The Fashion Shoe Company, the break-even point is as follows: Breakeven units = Fixed cost/unit contribution Margin Unit contribution margin Fixed cost Breakeven units Breakeven sales 12 150,000 12,500 $ 375,000 Units * selling price Selling price - variable cost

Section B
Section B of this assignment requires the preparation of a CVP graph that shows cost and revenue data for Shop 48 from zero shoes up to 17,000 pairs of shoes sold per year with a clear indication of the break-even point on the graph. A CVP graph highlights CVP relationships over wide ranges of activity and can give managers a perspective that can be obtained in no other way (Cost Volume Profit Relationship, 2011). As can be clearly seen in a CVP graph, sales quantity shown below the break-even point on the graph will represent a loss for the company. The sales quantity shown above the break-even point on the graph will represent a profit for the company. For Shop 48 of The Fashion Shoe Company, the CVP graph is depicted below:

Analysis
Shoes 0 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000 11000 12000 13000 14000 15000 16000 17000 Total cost 150000 168000 186000 204000 222000 240000 258000 276,00 294000 312000 330000 348000 366000 384000 402000 420000 438000 456000 Total Revenue 0

CVP Graph
$ 600,000 500,000 400,000 300,000 200,000 100,000 -

s /R v

60000 90000 120000 150000 180000 210000 240000 270000 300000 330000 360000 390000 420000 450000 480000 510000

Section C
Section C of this assignment requires the determination of Shop 48s net operating income or loss if 12,000 pairs of shoes are sold each year. By determining net operating income or loss, a manager gains an understanding of the companys performance. If the value is positive, it is referred to as operating income. If the value is negative, it is referred to as an operating loss. Below is the determination for Shop 48 of The Fashion Shoe Company: Shoes sold Total revenue Total variable cost Contribution margin Fixed cost Operating income/(loss) 12,000 360,000 (Shoes sold * Selling Price) 216,000 (Shoes sold * TVC) 144,000 (Total Revenue TVC) 150,000 (6,000) (CM FC)

0 2, 00 0 4, 00 0 6, 00 0 8, 00 10 0 ,0 0 12 0 ,0 00 14 ,0 0 16 0 ,0 00

Sh

30000

Total Cost Total Revenue

Analysis

Section D
Section D of this assignment requires the determination of the new break-even point in dollar sales and in unit sales if the store manager of Shop 48 is paid an incentive commission of 75 cents on top of their regular commission rate. The added 75 cent incentive commission will increase the variable cost for the company. This will increase the break-even point for dollar sales as well as unit sales as more unit sales will be required to generate the dollar sales necessary to cover the incentive commission. The explanation of the new break-even points is shown below. Selling Price New variable cost Contribution margin Fixed cost Breakeven units Breakeven sales 30 18.75 11.25 150,000 13,333.33 $400,000.00

increase by $0.75 (selling price - new VC) (FC/CM)

(Break-even points units * Selling Price)

Section E
Section E of this assignment requires the determination of the shops net operating income or loss if 15,000 pairs of shoes are sold with a 50 cent commission sold on each pair of shoes sold in excess of the original break-even point. The total variable costs will increase in this situation because the 50 cent commission will figure into this amount. The shops sale of 15,000 pairs of shoes will cause its contribution margin to exceed its fixed cost resulting in an operating income instead of a loss. This information is shown in the breakdown below. Shoes Sold Total revenue Total variable cost Contribution margin Fixed Cost Operating income/(loss)

15,000 450,000 271,250 178,750 150,000 28,750

(shoes sold * selling price)

This cost will be higher by (15,000-12,396.65) X $0.5 - $0.50 per shoe in excess of breakeven

(TR TVC)

(CM FC)

Analysis

Section F
Section F of this assignment requires the calculation of the new break-even point if all sales commissions are eliminated and fixed salaries are increased by $31,500 annually. The calculation is based off of the original data and a recommendation must be given. Because variable costs are reduced and fixed costs are increase, the results are a decrease in the amount of units that must be sold along with a decrease in the amount of dollar sales required to cover all costs. A recommendation based on this information would be to make the change since the breakeven point is lower. There is less risk involved in this method. The calculation of this information is shown below. Selling Price $30 New variable cost Contribution margin Fixed cost Breakeven units Breakeven sales

13.5 16.5 181,500 11,000 $330,000

No commission (Selling Price New variable cost) Increase by 31,500

Concl

ion

The basic CVP analysis can be a very important tool for any manager. It gives them an understanding of how price, volume, and profit are all tied together to create a successful business structure. The assignment given is a clear example as to the many ways CVP analysis can be used by a manager in making the optimal business decisions. By following the steps exemplified in this assignment, a manager can be assured they are following a strategy for success in management decisions.

Analysis References

Cost Volume Profit Relationship-(CVP Analysis). (2011). Accountingformanagement.com. Retrieved January 30, 2011 from http://www.accountingformanagement.com/ cost_volume_profit.htm.