These videos cover cost volume profit analysis which include margin of safety, contribution margin ratio, target profit net of tax and break-even in sales.
[vc_video link=”https://youtu.be/CQkVx5t1CLI” title=”Cost Volume Profit Analysis | Break -Even”]
[vc_video link=”https://youtu.be/MUIyD3CDPHo” title=”Cost Volume Profit Analysis | Target Profit “]
Cost volume profit analysis is based on a simple model of how profits respond to prices, costs, and volume. This model can be used to answer a variety of critical questions such as what is the company’s break-even volume, what is its margin of safety, and what is likely to happen if specific changes are made in prices, costs, and volume.
A Cost volume profit graph depicts the relationships between unit sales on the one hand and fixed expenses, variable expenses, total expenses, total sales, and profits on the other hand. The profit graph is simpler than the Cost volume profit graph and shows how profits depend on sales. The Cost volume profit and profit graphs are useful for developing intuition about how costs and profits respond to changes in sales.
The contribution margin ratio is the ratio of the total contribution margin to total sales. This ratio can be used to quickly estimate what impact a change in total sales would have on net operating income. The ratio is also useful in break-even analysis.
Break-even analysis is used to estimate how much sales would have to be to just break even. The unit sales required to break even can be estimated by dividing the fixed expense by the unit contribution margin. Target profit analysis is used to estimate how much sales would have to be to attain a specified target profit. The unit sales required to attain the target profit can be estimated by dividing the sum of the target profit and fixed expense by the unit contribution margin.
The margin of safety is the amount by which the company’s current sales exceeds breakeven sales.
The degree of operating leverage allows quick estimation of what impact a given percentage change in sales would have on the company’s net operating income. The higher the degree of operating leverage, the greater is the impact on the company’s profits. The degree of operating leverage is not constant—it depends on the company’s current level of sales.
The profits of a multiproduct company are affected by its sales mix. Changes in the sales mix can affect the break-even point, margin of safety, and other critical factors.