Explain the components of cost-volume-profit analysis.
o What does each of the components mean?
o Based on the formulas you have reviewed, what happens to contribution margin per
unit when unit selling prices increase? Illustrate your explanation with an example
from a fictitious company of how an increase in unit selling prices might affect
contribution margin.
o When fixed costs decrease, what does this do for sales? Illustrate your explanation
with an example from a fictitious company.
o Define contribution ratios.
o What happens to contribution ratios as one of the components changes?
Answers
1) The basic components of cost-volume-profit analysis are:
a) Volume or level of activity: The amount of output or sales
b) Unit selling price: This is the price the firm assigns for selling its products
c) Variable cost per unit: Those are costs that stay fixed on a per unit basis, but change in total with different levels of activity.
d) Total Fixed Costs. Those are fixed in total, but vary on a per unit basis depending on the level of activity.
e) Sales Mix: The relative percentage in which each product is sold when a company sells more than one product.
2) Unit Contribution Margin = Unit Sales Price – Unit Variable Cost
Based on the above formula, the Unit Contribution Margin (UCM) increases when the Sales Price increases.
For example: If a company is selling a product at a sales price of $10 per unit, and the variable cost per unit is $4, then the contribution margin would be ($10 - $4) = $6. If the sales price increases to $12, then the contribution margin would equal ($12 - $4) - $8 per unit.
3) Breakeven Sales is defined as the level of sales that would cover all Variable and Fixed Costs resulting in a zero profit for the company. The Breakeven point in unit sales = .
Therefore if the Fixed Costs are $15,000, and the Unit Contribution Margin is $5, then the Breakeven point = $15,000 ÷ $5 = 3,000 units. If Fixed Costs decrease to $10,000, then the breakeven point in unit sales = $10,000 ÷ $5 = 2,000 units.
4) Contribution Margin Ratio is the contribution margin per unit divided by the
unit selling price.
If originally a company is selling a product for $100, and the Unit Contribution Margin is $50, then the Contribution Margin Ratio = $50 ÷ $100 = 0.5 = 50%.
If the selling price increases to $150, and the Unit Contribution Margin remains at $50, then the Contribution Margin Ratio = $50 ÷ $150 = 0.3333 = 33.33%.
If the selling price remains at $100, and the Unit Contribution Margin decreases to $20, then the Contribution Margin Ratio = $20 ÷ $100 = 0.2 = 20%.