Sales mix break


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Sales mix break

  1. 1. SALES MIX AND ITS EFFECTS ON CVP ANALYSIS:Sales mix is the proportions of different products and services that comprise the total sales of acompany. In most cases, each product or service that a company provides has a different profit, sochanges in sales mix (even if sales levels remain the same) usually result in differing amounts of profit.Thus, if a company introduces a new product that has a low profit, and which it sells aggressively, it isquite possible that profits will decline even as sales increase. Conversely, if a company elects to drop alow-profit product line and instead push sales of a higher-profit product line, total profits can actuallyincrease even as total sales decline.One of the best ways for a company to improve its profits in a low-growth market is to use its marketingand sales activities to alter the sales mix in favor of those products having the largest amount of profitassociated with them. Sales managers have to be aware of sales mix when they devise commission plans for the sales staff,since the intent should be to incentivize the sales staff to sell high-profit items. Otherwise, a poorly-constructed commission plan could push the sales staff in the direction of selling the wrong products,which alters the sales mix and results in lower profits. A cost accounting variance called "sales mix variance" is used to measure the difference in unit volumesin the actual sales mix from the planned sales mix. Follow these steps to calculate it at the individualproduct level:1. Subtract budgeted unit volume from actual unit volume and multiply by the standard contributionmargin2. Do the same for each of the products sold3. Aggregate this information to arrive at the sales mix variance for the companyThe formula is:(Actual unit sales - Budgeted unit sales) x Budgeted contribution marginCVP analysis is: the study of the effects of changes in costs and volume on a company’s profitCVP analysis is important to profit planningCVP analysis is critical in management decisions such as: determining product mix, maximizing use ofproduction facilities, and setting selling pricesBecause CVP is so important, management often wants the information reported in a special formatincome statement.The CVP income statement is for internal use only, classifies costs and expenses as fixed or variable,reports a contribution margin in the body of the statement.
  2. 2. Sales Mix and CVP Analysis:If a company sells multiple products, break even analysis is somewhat more complex than discussed inthe topic breakeven point calculation. The reason is that the different products will have different sellingprices, different costs, and different contribution margins. Consequently, the breakeven point willdepend on the mix in which the various products are sold.Example:1 AB Company Product A Product B TotalSales $20,000 100% 80,000 100% 100,000 100%Less Variable expenses 15,000 75% 40,000 50% 55,000 55% ------- ----- ------ ----- ------ ----Contribution margin 5,000 25% 40,000 50% 45,000 45% ===== ===== ===== =====Less fixed expenses 27,000 -------Net operating income 18,000 ===== Computation / Calculation of break even point: Fixed expenses / Overall contribution margin 27,000 / 0.45 $60,000$60,000 sales represent the breakeven point for the company as long as the sales mix does not change.If the sales mix changes, then the breakeven point will also change.
  3. 3. Example:2 AB Company Product A Product B TotalSales 80,000 100% 20,000 100% 100,000 100%Less variable expenses 60,000 75% 10,000 50% 70,000 70% ------- ----- ------ ----- ------ -----Contribution margin 20,000 25% 10,000 50% 30,000 30% ====== ====== ====== ====== ======Fixed expenses 27,000 ------Net operating income 3,000 ====== Computation / Calculation of break even point: Fixed expenses / Overall contribution margin $27,000 / 0.3 $90,000Although sales have remained unchanged at $100,000, the sales mix is exactly the reverse of what it wasin example1, with the bulk of sales now coming from the less profitable product A. Notice that thischange in the sales mix has caused both the overall contribution margin and total profits to dropsharply. The overall contribution margin ratio (CM ratio) has dropped from 45% to 30% and netoperating income has dropped from $18,000 to $3,000. The companys break even point is no longer$60,000 in sales. Since the company is now realizing less contribution margin per dollar of sales, it takesmore sales to cover the same amount of fixed costs. Thus the break even point has increased from$60,000 to $90,000 in sales per year.
  4. 4. Weighted Average Contribution MarginThe weighted average contribution margin is the average amount that a group of products or servicescontribute to paying down the fixed costs of a business. The measurement is compiled by accumulatingthe revenue for all items being measured, subtracting from this aggregate revenue figure the totalamount of all variable expenses related to the items in the measurement group, and dividing by thenumber of units sold.For the purposes of this calculation, variable expenses are those that vary directly with sales. Thus, anexpense is only incurred if a sale is generated. Examples of these variable expenses are:■Direct materials■Commissions■Piece rate wages■Freight outThus, the calculation of the weighted average contribution margin is:(Aggregate sales - Aggregate variable expenses) / Number of units sold For example: ABC International has two product lines, each of which is responsible for 50% of sales.The contribution from Line A is $100,000 and the contribution from Line B is $50,000. In aggregate, ABCsold 15,000 units. This means that the weighted average contribution margin for the entire business is$10/unit (calculated as $150,000 total contribution / 15,000 units).The weighted average contribution margin is useful for calculating the number of units that a businessmust sell in order to cover its fixed expenses and at least break even, if not earn a profit. This analysis isknown as cost-volume-profit analysis.To continue with the example, ABC International has calculated that it generates a contribution marginof $10 per unit, based on current sales of 15,000 units. However, the business also has $200,000 of fixedcosts, so it is currently losing $50,000 per period. ABC can use the weighted average contribution marginto calculate how many units it must sell in order to break even. Thus, fixed costs of $200,000 divided bya contribution margin of $10 per unit results in a requirement of 20,000 in unit sales in order to breakeven.