Cost-Volume-Profit Analysis
Mary Willis; advertising manager for Bargain Shoe Stores, and she is currently working on a significant promotion campaign. Ms. Willis proposed a 5% price decrease (40%-38%) that is projected to increase the sales volume by 20%. The variable cost of each pair of shoes is $24, and the proposed reduction in the value of each pair of shoes from $40 to $38 with the projected sale volume of $24,000 up from $20,000.
The Bargain Shoe Store’s Management is impressed with Ms. Willis’s promotional campaign but also concerned with the effects of these changes on the break-even point and the Margin of Safety. The Accounting Department provides a Cost-Volume-Profit (CVP) Analysis that estimates how much variation in the Bargain Shoe Store’s Cost, sales volume, and the price affects the company’s profit. The CVP is a potent and most widely used tool that helps the Managers emulated better-informed decisions about Ms. Willis’s proposal.
Cost-Volume-Profit
Cost-volume-profit (CVP) analysis examines the relationship between costs and profit to the volume of business to maximize profits. It helps the managers to set selling prices, determine product mix, and maximize the use of production inputs (Kimmel, Weygandt, and Kieso, 2016). The CVP Analysis for the proposal will support the Business Managers in their understanding of the changes the promotion campaign has on the operational profit of Bargain Shoe Stores.
Break-even Point Calculations
The Accounting Department will compute the current break-even point; in comparison to the break-even points of Ms. Willis’s idea.
Selling Price less the Variable Cost= Contribution Margin
Fixed cost divided by Contribution Margin = Break-even Point into units
Break-even Point in value = Break-even point in units multiply by selling price
The contribution margin is sales less the variable costs
The formula shows when the revenues are equal to the costs.
The margin of Safety Calculations
The Margin of Safety is the expected sales before the break-even point of the business. It informs the business manager of the risk subjected by the change of the sales volume.
The margin of Safety= (Current Sales level – Breakeven Point Sales) / Current Sales level.
Cost-Volume-Profit Income Statement for Current operation
The contribution margin income statement shows the difference in the value of fixed and variable income costs. On the income statement, there is variation in the gross profit margin and the contribution margin. The gross profit margin equals sales less the cost of goods sold. The cost of products sold includes fixed add the variable costs.
The contribution margin ratio is a margin expressed as a percentage of total sales. With regard to GAAP financial statements rule, it is internally used by managers (Peavler, 2016). Calculating this ratio is essential to the Business Managers as it addresses the profit potential of Bargain Shoe Stores. Operating Income = (Price X number of Units Sold) – (Variable Cost per Unit X Number of Units Sold) – Total Fixed Costs.
MEMORANDUM
TO: Bargain Shoe Store Management
FROM: Sadia Romero, Senior Accountant
DATE: October 13, 2019
SUBJECT: Mary Willis, Advertising manager
As request by Management, the Cost-Volume-Profit Analysis completed for Mary Willis’s promotional campaign.
The figures below were used in the calculation of the analysis.
Fixed Cost $270,000
Variable Cost $24
Additional Fixed Cost $24,000
Sales Price Discount
Current Sale Price per Unit $4
Discounted Sales Price per Unit $38
Proposed Increase in Sales
Current Sales Volume $20,000
Recommended Sales Volume = $24,000
The current break-even point in units is 16,875, and that posted by Mary is 21,000. See table 1. Current Break-even Point in units in comparison to Mary’s Break-even Point; the current break-even point in value is $670,000, and Mary’s $798,000.
The current margin of safety ratio represents 16%, and that posted by Mary shows a margin of Safety ratio of 13%. See table 2 — Current Margin of Safety Ratio in comparison to Mary’s Margin of Safety Ratio.
The Cost-Volume-Profit statement for current and that posted by Mary, represents a variation of current revenue of $800,000 after Mary’s views it rises to $912,000. Current contribution is $320,000 and, after Mary’s report the reading is $336,000.
The current fixed cost is $270,000, and that after Mary’s idea shows the fixed cost value is $294,000. The current net profit of the firm is $50,000, and after Mary’s approach is lower at $42,000. See table 3.Cost-Volume-Profit income statement for ongoing operations and Mary’s changes.
Therefore from the above information, it is clear that the company should consider Mary’s idea.
| The Current Break-even Point in units, and compared to the Break-even Point in units of Mary’s reports. | ||
| Current Break-even Point | Mary’s Break-even Point | |
| Sale Price (A) | 40 | 38 |
| Variable Cost (B) | 24 | 24 |
| Contribution Margin ( A – B) | 16 | 14 |
| Fixed Cost | 270,000 | 294,000 |
| Break-even point in units = Fixed Cost / Contribution Margin | ||
| 270000/16 | 294000/14 | |
| Break-even point in units | 16,875 | 21,000 |
| Break-even point in value = Break-even point in units x Sale price | ||
| 16,875 x 40 | 21,000 x 38 | |
| Break-even point in value | 675,000 | 798,000 |
See Table 1. Current Break-even Point in units in comparison to Mary’s Break-even Point
| The Margin of Safety Ratio for current operations compared to changes proposed by Mary’s ideas. | ||
| Current Margin of Safety Ratio | Mary’s Margin of Safety Ratio | |
| Break-even point sales | 16,875 | 21,000 |
| Budgeted Sales | 20,000 | 24,000 |
| (20000 -16875)/20000 x 100 | (24000 – 21000 )/24000 x 100 | |
| Margin of safety = | 16% | 13% |
| Margin of Safety = (Budgeted Sales – Breakeven point sales) / Budgeted sales | ||
See Table 2. Current Margin of Safety Ratio in comparison to Mary’s Margin of Safety Ratio
| The Cost-Volume-Profit income statement for current operations and that after Mary’s changes. | ||
| Bargain Shoe Store | ||
| CVP Income Statement | ||
| Current Situation | After Mary’s idea | |
| Sales unit | 20,000 | 24,000 |
| Sale Price | 40 | 38 |
| Revenue = Sale Price * Price (X) | 800,000 | 912,000 |
| Variable Cost = Number of units * Cost (12) (Y) | 480,000 | 576,000 |
| Contribution (Z) ( X – Y) | 320,000 | 336,000 |
| Fixed Cost ( D) | 270,000 | 294,000 |
| Net Profit ( Z – D) | 50,000 | 42,000 |
See Table 3. Cost-Volume-Profit income statement for current operations and Mary’s change
Conclusion
To conclude, the organization is considered to have insufficient liquidity. A possible solution should be formulated to avoid bankrupt by selling off some of the accounts receivable amounts and reducing the amount of credit extended to clients to six months. Furthermore, evaluating the number of days of financing offered to customers is a paramount factor in debt analysis and liquidity measure. Reducing the purchase of equipment and other expenses will also help the firm to keep its employees, the clients and effectively handle their cash.
References
Heisinger, K., & Hoyle, J. (2013). Managerial Accounting (Vol. 1). WordPress.
Investing Answers. (2017). Generally Accepted Accounting Principles (GAAP). Retrieved from Investing Answers: http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/generally-accepted-accounting-principles-gaap-992
Kimmel, P., Weygandt, J., & Kieso, D. (2016). Accounting: Tools for business decision making (6th edition.). Hoboken, NJ: John Wiley & Sons.
Peavler, R. (2016). Contribution margin income statement – Breakeven point in dollars. Retrieved from The Balance: https://www.thebalance.com/contribution-margin-income-statement-393473