The cost-volume-profit analysis is a business tool which companies utilize in order to analyze the effects of changes on costs and volume in its profits. It has five major components namely, volume or level of activity, unit selling prices, variable cost per unit, total fixed cost, and sales mix. The volume of level of activity refers to the quantity of the product which is sold. Unit selling prices is the amount that the company sells one unit of its product to the customers. In CVP analysis, costs are classified as a either variable or fixed.
Variable cost per unit refers to the costs which can be directly attributed to the production of the product like direct labor and materials. Fixed costs on the other hand, are costs which are incurred even if the company increase or lessen its level of activity. Sales mix is applicable to business organizations which has two or more products. It refers to the breakdown of sales according to product types. 3&4. Based on the formulas you have reviewed, what happens to contribution margin per unit when unit selling prices increase?
Illustrate your explanation with an example from a fictitious company of how an increase in unit selling prices might affect contribution margin. Holding everything constant, an increase in the unit prices will directly increase the contribution margin per unit by the amount of price increase. For example, company A sells a burger for $2. 00 incurring $1. 50 for the production. Contribution margin is then $0. 50 ($2. 00-$1. 50). If unit price is raised from $2. 00 to $2. 50, the company’s contribution margin per unit will increase by $0.
50 which is equal to the amount of price increase ($2. 50-$1. 50). The contribution margin due to this price increase will be equal to $1. 00. 5. When fixed costs decrease, what does this do for sales? Illustrate your explanation with an example from a fictitious company. A decrease in fixed cost will have a direct impact in the required sales of the company in order to reach break-even or generate a target profit. In general, a decrease in fixed cost lowers the required sales as part of the previous fixed cost will now be counted as profit.
Take for example, Starjuice which sells orange juice for $1. 00 per bottle/unit, has variable cost of $0. 70 per unit, and fixed expenses of $10,000. Starjuice wants to generate a profit of $5,000. Thus, it needs to sell ($10,000+$5,000)/($1. 00-$0. 70), 50,000 bottles of orange juice or $50,000 in total sales to reach this target. However, when fixed cost has decreased to $4,000, then the company only needs to sell ($4,000+$5,000)/($1. 00-$0. 70), 30,000 bottles or $30,000 in total sales.
6&7. Define contribution ratios. What happens to contribution ratios as one of the components changes? The contribution margin ratio refers to the ratio of the contribution margin to the unit selling price. For the Starjuice example above, the contribution margin ratio is 0. 30 or 30% as the contribution margin of $0. 30 is 30% of the total selling price of $1. 00. The changes in the contribution margin are often facilitated by the changes in unit selling price and variable costs.
An increase in the unit selling price which is discussed above to enhance contribution margin will subsequently bring a rise in contribution ratio. On the other hand, a decrease in selling price will also bring a decline in contribution ratio. Increase in variable cost will directly lessen contribution margin thereby lowering contribution ratio. However, a decrease in variable cost will increase contribution margin and increasing contribution ratio.