Cost-Volume-Profit (CVP) Analysis: Breaking Even and Determining Profitability - Prof. Hyu, Study notes of Hospitality and Tourism

Download Cost-Volume-Profit (CVP) Analysis: Breaking Even and Determining Profitability - Prof. Hyu and more Study notes Hospitality and Tourism in PDF only on Docsity! 1 1 Ch. 7 Cost-Volume-Profit Analysis • Now, we know: – Costs can be divided into two categories: • Fixed Cost & Variable Cost – Then, the next question is: • How much revenues are required to breakeven under the current cost structure? • How much revenues are necessary to make your expected profit? Revenues: Activity x Price -Variable cost: Activity x VC/u - Fixed cost: Fixed Amount (Operating) Income (Profit) Simplified Income Statement 2 Ch. 7 Cost-Volume-Profit Analysis • Cost-Volume-Profit (CVP) Analysis: – Used to determine the revenues required at any desired profit level (including “no profit/no loss” level). – Enables managers to think about their revenues in advance to determine expected profit from their operations. – Expresses the relationships among various costs, sales volume, and profits in equation forms or graphic forms. – Often referred to as a Breakeven Analysis. • Breakeven Point (BEP) is the point of sales (in $ or in volume) where all the costs are paid out with no profit. 3 Ch. 7 Cost-Volume-Profit Analysis • CVP Assumptions, Limitations, & Relationships – Fixed costs remain the same (in dollar amount). – Variable costs move in a linear fashion with revenues (at a fixed percentage: i.e., 40% of sales price), which means; • The Unit Variable Cost does not change. • The Variable Cost (VC) % over the sales remains the same. – Revenues are directly proportional to volume of sales (linear: i.e., sales price x number of units sold), which means; • The unit price (ADR, Average Check price..) does not change. – All costs must be assigned to individual operated departments. – CVP analysis does not consider qualitative factors, such as employee morale, dedication, customer loyalty, etc. 2 4 Ch. 7 Cost-Volume-Profit Analysis • Let’s restructure the Income Statement with one more piece of information: – Contribution Margin – This is almost the same as “Gross Profit.” • At breakeven point, the “Contribution Margin” must be the same as the Fixed Cost. • Let’s think about the following example. – Room Price is $50. – Each room costs $15 as its V.C. – Total Fixed Cost is $7500. – How many rooms should be sold to breakeven? Revenues: Activity x Price -Variable cost: Activity x VC/u = Contribution Margin -Fixed cost: Fixed Amount =(Operating) Income (Profit) Income Statement 5 Ch. 7 Cost-Volume-Profit Analysis With the information given below; – Room Price is $50. – Each room costs $15 as its V.C. – Total Fixed Cost is $7500. – How many rooms should be sold to breakeven? 1. Determine how many rooms must be sold to breakeven. 2. If the company wants to have $1,500 for EBT (Earnings before Tax), how many room should be sold? * Revenues = Price x Activity * Var. Cost = VC/u x Activity * Fixed Cost = Fixed Amount (given) * Revenues – Total Costs = Profit Income Statement Revenues: -Variable cost: = CM -Fixed cost: =Profit (b4 tax) $???? -$???? =$???? $7,500 = -$0- 6 Ch. 7 Cost-Volume-Profit Analysis • Equation Forms: Sales – Costs = Profit Sales (Revenues) = Selling Price x Units Sold (= activity) where, Selling Price can be: Average Room Rate (ADR) (e.g., $50 per night) Average Check Price (e.g.,$20 per check) Per Capita Spending (e.g., $75 per entry) Units Sold can be Number of Rooms Sold (e.g., 5,000 per year) Number of Customers Served (e.g., 6,000 per month) Variable Cost = VC/unit x Units Sold (= activity) Sales – VC = Contribution Margin
(Price – VC/unit) x Units Sold The Contribution Margin must be the same as the Fixed Cost amount to breakeven. 5 13 Ch. 7 Cost-Volume-Profit Analysis • Verification: at the Breakeven Point, – Selling price (S: $40) – No. of units sold (X: 7,500) – Variable cost per unit (V: $15) – Total fixed cost (F: $187,500 per year) Total Revenue = SX = $40 x 7,500 = $300,000 -Total V. C =VX = $15 x 7,500 = $112,500 -Total F. C = remains the same at $187,500 Profit/(Loss) = - 0 – In other words, they have to achieve the occupancy rate of (7,500/(30 x 365)) = 68.5% 14 Ch. 7 Cost-Volume-Profit Analysis • If they sold more than 7,500 rooms (higher than BEP), – Selling price (S: $40) – No. of units sold (X: 9,500) – Variable cost per unit (V: $15) – Total fixed cost (F: $187,500 per year) Total Revenue = SX = $40 x 9,500 = $380,000 -Total V. C =VX = $15 x 9,500 = $142,500 -Total F. C = remains the same at $187,500 Net Profit (Income) $ 50,000 15 Ch. 7 Cost-Volume-Profit Analysis 0 $ Number of Rooms (activity) 9,500 $40 x 9,500 $380,000 $187,500 $187,500 + $15 x 9,500 $330,000 6 16 Ch. 7 Cost-Volume-Profit Analysis • If they sold less than 7,500 rooms (lower than BEP), – Selling price (S: $40) – No. of units sold (X: 5,500) – Variable cost per unit (V: $15) – Total fixed cost (F: $187,500 per year) Total Revenue = SX = $40 x 5,500 = 220,000 -Total V. C =VX = $15 x 5,500 = $ 82,500 -Total F. C = remains the same at $187,500 Net Loss -$ 50,000 What is the result called, and what is the amount? Contribution Margin $137,500 17 Ch. 7 Cost-Volume-Profit Analysis 0 Fixed Costs=$187,500 Total Cost=$187,500 + 15X Variable Costs=15X Revenues=40X BEP # of rooms sold (activity) $ 5,500 7,500 Rev:220,000 BEP 300,000 $50,000 Net Loss TC $270,000 18 Ch. 7 Cost-Volume-Profit Analysis • Is it always possible to obtain selling price and variable cost per unit? • What if there were no such information? • An extension of Gross Profit Margin can be used to perform Breakeven Analysis. • Gross Profit = Sales (Revenues) – Cost of Goods Sold • Cost of Good Sold (Cost of Sales) is a typical Variable Cost. – From the Income Statement of a company, try to decide which costs should be grouped into the category of Variable Cost. 7 19 Ch. 7 Cost-Volume-Profit Analysis • Use the total of all Variable Costs, and find out the percentage of it against the total sales (revenues). • For example, if the total sales is $2,000,000, and the total variable cost is $800,000, then the total variable cost is 40% of the sales (revenues). $800,000 / $2,000,000 = 0.4 (=40%) • The extended Gross Profit Margin (Contribution Margin Ratio: CMR) is 1 – 0.4 = 0.6 (60%  CMR) • BEP can be obtained by dividing the Total Fixed Cost by the extended Gross Profit Margin (F / CMR) will continue