Accounting-Finance

Learning Materials For Accounting, Management , Finance And Economics.

Sunday, October 2, 2011

Concept Of Cash Break-Even Point

Accounting ,
Break-Even Point tells about the volume of sales needed to cover all operating expenses. If sales equals to Break-even point then the company neither earns profit nor suffers from loss. If company can not achieve BEP, the company suffers from loss. If the company suffers from loss, does it mean that company faces with the difficulties in paying its monthly bills for rent, salary, suppliers and labors? Not necessarily, the issue can be resolved by computing cash Break-even point. Form that the BEP formula can be taken on basis.

BEP in units = Fixed costs/Selling price per unit- variable costs per unit.

Fixed costs include certain non-cash expenses like depreciation and amortization of expenses, for which no cash is needed in short-run. Therefore, company can exclude depreciation and other non-cash expenses in the short-run. If only the cash costs are included in fixed costs we get cash BEP.

Cash BEP= Fixed costs- Non-cash expenses/Selling price per unit - variable cost per unit.
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Assumptions in Cost-Volume-Profit (CVP) Analysis

Accounting ,
Certain underlying assumptions place definite limitations on the use of CVP analysis. Therefore, it is essential that anyone preparing CVP information should be aware of the underlying assumptions on which the information is to be derived. If these assumptions are not recognized, serious errors may result and incorrect conclusions may be drawn from the analysis.

Some of the key assumptions underlying cost-volume-profit analysis are as follows:

1. All costs can be classified as fixed and variable

while developing and applying cost-profit-analysis including the break-even analysis, it is assumed that all costs can be classified into fixed and variable costs. In fact, it is difficult to identify each and every cost element as fixed and variable. In the traditional type of recording costs, it is very difficult to segregate costs into fixed and variable. Moreover, the flexible policy of the company also makes it more difficult to identify the cost as fixed and variable.
If anyone fails to identify the cost as fixed and variable, the application of cost-volume-profit analysis becomes almost impossible.

2. Behavior or costs will be linear within the relevant range

Cost-volume-profit (CVP) analysis assumes that total fixed costs do not change in the short-run within the relevant range. Total variable costs are exactly proportionate to sales volume. But in reality, cost behavior may not remain constant.

 3. Difficulty of steps fixed costs

Relevant range for many costs is very short. In that case it becomes very uncomfortable to compute the required volume because it is difficult to say that which the relevant range for our needed volume is.

4. Selling price remains constant for any volume

Indeed, most often quantity discount is offered for different lots of purchase. This causes difficulty in determining the contribution margin per unit(CMPU) and contribution margin ratio.

5. There is no significant change in the size of inventory

Application of cost-volume-profit (CVP) analysis is possible only under following two situations:
* Either the company should follow variable costing for the inventoriable product cost.
* Or all the production volume should be sold within the same period.

6. Cost-volume-profit (CVP) analysis applies only to a short-term time horizon

 CVP analysis is a short term planning tool, because nothing remains stable in the long-run. In the condition of changing variables, all equations of CVP analysis need readjustment of figures.
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Concept Of CVP Analysis Under Changing Situations Or Sensitivity Analysis

Accounting ,
Sensitivity analysis is the measurement of responsiveness in outcome with the change in determinant variables. We know that the goal of a business enterprise is to maximize profits.
Profits are the excess of revenues over the total costs.
Net Profits = Total Sales Revenue- Total Costs
= Sales Units X Selling price per unit) -(Sales Units-Unit variable costs -Fixed Costs -Taxes)
So, Profit= f(Sales volume, Selling price, Variable costs, Fixed costs, Taxes etc.)

It means that profits are the functions of volume, price, variable costs, fixed costs, taxes and so on. But none of the factors remain unchanged. Sometimes the manager can intentionally change the price and cost factors as a part of strategic decisions. But the strategy should focus more on the factors which is more sensitive or responsive of profits. Therefore, to measure the sensitivity of CVP factors we can see the impact of certain percentage of change in volume, price or cost factors on net profits.

Therefore, sensitivity analysis is the measurement of elasticity of change in cost-volume-profit factors on the break even point or the given profits. A strategists or managers should focus on the factors which is more responsive to profits.
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Concept Of The Margin Of Safety (M/S)

Accounting ,
The margin of safety(M/S) is the excess of budgeted (or actual) sales over the break-even sales. Margin of safety states where losses begin if the sales drop. Margin of safety = Budgeted sales- Break-even sales. The higher the margin of safety, the safer the position of the business.
A margin of safety ratio is the percentage of margin of safety to the budgeted sales.

Margin of safety ratio(in %) = (Budgeted sales - Break-even sales)/Budgeted sales
Break-even ratio = 100% - Margin of safety ratio
There exists a close relationship between the margin of safety and the net profits.
Net profits before tax = (Budgeted sales - Break-even sales) X P/V ratio
= Margin of safety X P/V ratio

Therefore, P/V ratio = Net profits before tax/Margin of safety

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Concept Of Break-Even Analysis And Break-Even Ratio

Accounting ,
Break-Even Analysis

Break-even analysis is that part of Cost-Volume-Profit Analysis which tells us about the level of sales at which revenues equals expenses thus showing a zero net income more precisely, such a sales point is called Break-Even Point. CVP analysis is sometimes referred to simply as break-even analysis. This is unfortunate because break-even analysis is just one part of the entire CVP analysis. Yet, it is always taken as an important part of profit planning as it gives the planner many insights into the data with which he or she is working. Profit planning of each firm begins with break-even analysis.

Example: Suppose, annual fixed costs of Rexona company are $ 100,000, selling price is $ 25 per unit, variable costs per unit is $ 15, contribution margin per unit(CMPU) is $ 10 and contribution margin ratio(C/M) is 40%. Calculate the Rexona,s break-even point(BEP) in units and in $.
Solution,
Rexona,s Break-even Point(BEP)
1. BEP(in units) = Fixed Costs/CMPU = $ 100,000/$ 10 = 10,000 units
2. BEP(in $) = Fixed Costs/C/M ratio = $100,000/0.40 = $ 250,000

Break-Even Ratio

Break-even ratio is the percentage of Break-even sales volume to sales volume at budgeted capacity. For example, if Break-even sales volume is 50,000 units and sales volume at budgeted capacity is 125,000 units, then break even ration is 40% if the company's plant capacity is 200,000 units, then break-even sales to capacity is 25% i.e, 50,000 units/200,000 units X 100.
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Wednesday, September 14, 2011

Approaches To Cost-Volume-Profit(CVP) Analysis

Accounting ,

1. Contribution Margin Statement Approach

Break even point(BEP) and other required cost volume profit relationships can be explained through contribution margin by following the variable costing income statement approach under which all fixed costs of the period are deducted out of the contribution margin of the same period. Only the variable costs vary proportionally to the level of outputs or sales.

2. Equation Or Formula Approach

The most often practiced approach of cost volume profit analysis is the equation or formula approach. In fact, we use equation approach to the solution of CVP analysis instead of the graph or the income statement.
As we know,
Sales= Variable expenses + Fixed expenses + Net profit
If sales volume= Q units, variable cost pe
r unit = V, total fixed cost= FC and selling price per unit = S, then the equation can be simplified as;
QS = QV+FC+Profit
or, QS-QV= FC+Profit
or, Q(S-V)= FC+ Profit

Simplifying the equation, we get:
Q = FC+Profit/S-V
Sales unit = FC+Profit/CMPU
Where,
S-V= CMPU

Above equation or formula can be applied to find out any one unknown value of the variable either fixed costs or variable costs.
In order to compute the sales revenue instead of the sales units the following formula is used:
Sales Revenue = Sales Units x Selling price per unit (SPPU)
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Concept And Meaning Of Contribution Margin Ratio

Accounting ,
Contribution margin expressed as a percentage on sales revenue is known as contribution ratio. The percentage of contribution to the total sales is referred as the C/M ratio. It is also the remaining percentage of the variable cost ratio.

CMPU = SPPU - VCPU
C/M Ratio = (Sales Revenue - Variable Costs)/Sales Revenue
Or,
C/M Ratio = (SPPU- VCPU)/SPPU
Or,
C/M Ratio = 1- Variable Cost Ratio
Or,
C/M Ratio = (Fixed Costs + Net profit(loss)/Sales Revenue
Where,
CMPU = Contribution margin per unit
SPPU = Selling price per unit
VCPU= Variable costs per unit
C/M Ratio = Contribution margin ratio.

Contribution margin per unit (CMPU) of $ 20 means each unit of sales contributes $ 20 towards the recovery of fixed cost first and then realization of profits.
A 45% C/M ratio means each dollar of sales revenue contributes $ 0.45 towards the recovery of fixed costs first and then realization of profits.

Contribution margin ratio sometimes referred to as Profit Volume Ratio(P/V Ratio). But one should be cleared with the P/V ratio that it is not the ratio of net profit to sales revenue. P/V ratio is the percentage of marginal profits(or change in profits) to marginal sales revenue.
Since fixed costs do not change within the relevant range in the short tun, net profits change by the same amount as the contribution margin change.

Therefore,
C/M Ratio = P/V Ratio = Change in contribution margin/change in sales revenue
= Change in net profits/change in sales revenue
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