Cost-Volume-Profit Relationship

Lecture 1
Gross margin versus contribution margin
What is contribution margin?
• Contribution margin is revenue less variable costs. Here, variable costs imply all variable costs
including production and non-production variable costs.
• Unit Contribution Margin (also know as UCM) is revenue per unit minus variable cost per unit.
Traditional versus contribution margin format of income statements
• Traditional income statement mixes variable and fixed costs but separates production cost and
non-production cost.
• Contribution margin statement mixes costs from different business functions such as production
and marketing but reports fixed costs and variable costs separately.
• Contribution margin statement is well suited for short-term managerial decisions.
Cost-Volume-Profit Analysis (CVP)
What is cost-volume-profit analysis?

Powerful financial tool for managers to understand the effect

of change in any or all of the following on profits:
Sales volume
Selling prices
Unit variable cost
Fixed costs
Product mix
CVP Scenario
Per Unit Percentage of Sales
Selling price $.50 100%
Variable cost of each item .40 80
Selling price less variable cost $.10 20%

Monthly fixed expenses:

Rent $1,000
Wages 4,500
Other 500
Total fixed expenses $6,000
Break-Even Point
The break-even point is the level
of sales at which revenue equals
expenses and net income is zero.
Equation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit

Unit Sales Unit Sales

sales × volume variable × volume
price in units expense in units

($0.5 × X) – ($0.4 × X) – $6,000 = $0

($0.1X) – $6,000 = $0
X = 60,000 units
What have we done so far?
Fixed expenses Break-even point
=
Unit contribution margin (in units)
Multiply by unit selling price to get the BEV in sales dollars
instead of sales units

Fixed expenses X unit selling price Break-even point

=
Unit contribution margin (in sales dollars)
Contribution Margin Method
60,000 units × $.50 = $30,000
of sales to break even

$6,000 fixed costs

÷ 20% (contribution-margin percentage)
= $30,000 of sales to break even
Cost-Volume-Profit Graph
Break-even sales point
$60000 60,000 units or $30,000
$50000 l in e
en ue
ev
$40000
Sal es r
Dollars

$30000
lin e
$20000 en s e
exp
Tot al
$10000 Fixed expense line
0
0 10 20 30 40 50 60 70 80 90 100
Units (thousands)
 Breakeven Problems for Airbus
Breakeven Volume
450
$ 15 Billion
400

350

300

250

200

150

100

50

2000
2005
2006
Breakeven Problems for Airbus

Slowing Demand Leaves Airbus With Challenge To Break-Even On A380 Program In 2015
Should Airbus be forced to reduce the production rate in 2015, the program would almost
certainly miss the goal to break-even that year. But Wilhelm remains “cautious about the
further potential for break-even below 30.”

Despite such optimism, there could be financial turbulence ahead for the A380. Airbus will
break even on the plane in 2015, 2016, and 2017, but that outlook doesn’t hold for 2018,
forcing the company to either spend heavily to improve the economics of its engines or
discontinue the program, Wilhelm said.
 Assumptions
Expenses can be classified into
variable and fixed categories.

The behavior of revenues and expenses

is linear over the relevant range.

Expect no changes in efficiency

and productivity.
 Assumptions

There is only one product.

The difference in inventory level

at the beginning and at the
end of a period is insignificant.