The document discusses cost-volume-profit analysis and operating leverage. It provides examples to illustrate how fixed costs and variable costs impact operating leverage and the break-even point. Specifically, it shows that when a company introduces fixed costs by purchasing equipment, their operating leverage increases such that profits increase by a greater percentage than the increase in sales. The document also discusses how a company can maximize total profits by optimizing their sales mix between multiple products with different costs and selling prices.

1. COST-VOLUME
PROFIT
ANALYSIS
BY:
JOY AMOR MANO
MBA

2. Operating leverage is a measure of how sensitive net operating
income is to percentage changes in sales. And acts as multiplier.
If operating leverage is high, a small percentage increase in sales
can produce a much larger percentage increase in net operating
income. It is high near the break even point and decreases as the
sales and profit increase.
The formula for calculating the degree of operating leverage is:
DOL = % change in EBIT
% change in Sales
OR
DOL = CONTRIBUTION MARGIN
NET OPERATING INCOME

3. Consider the following:
Assume that an Mallow produces wooden toys in his garage and sells each
toy for $10. No power equipment or fixed costs are used to produce the
toys. Assume that his variable costs (his labor and materials) are 60% of
sales. Let's assume first that he sells 100 toys a year, then assume that his
sales increase the next year to 200 toys. His profit for each year would be:
100 toys sold 200 toys sold %
Change
Sales (@$10 each) $ 1,000 $ 2,000 100%
-Variable costs (@60%) $ 600 $ 1,200
Contribution Margin $ 400 $ 800
-Fixed costs $ 0 $ 0
EBIT $ 400 $ 800 100%
DOL = % change in EBIT / % change in Sales = 100% / 100% = 1
or
=Contribution Margin/EBIT = 400/400 = 1
If a company has no fixed costs, its percentage change in EBIT will be the
same as its percentage change in Sales. In other words, there will be no
magnification of income

4. Now consider what would have happened if he had instead decided to buy
some small power tools (sander, band saw, etc.). He takes out a loan and will
pay off the loan over the lifetime of the tools. The payments on the equipment
are $200 a year. In return, it now takes him less time (and less wasted
material) to produce the toys. As a result of buying the tools, he reduces his
variable costs to 40% of sales. (He has now substituted a fixed cost for some
of the variable cost.)
100 toys sold 200 toys sold % Change
Sales (@$10 each) $ 1,000 $ 2,000 100%
-Variable costs (@40%) $ 400 $ 800
Contribution Margin $ 600 $ 1,600
-Fixed costs $ 200 $ 200
-EBIT $ 400 $ 1,000 150%
DOL = % change in EBIT / % change in Sales = 150% / 100% = 1.50
or
=Contribution Margin/EBIT = 600/400 = 1.5
The substitution of fixed costs for variable costs now results in a magnification
of profits The percentage change in profits will be 1.50 times the percentage
change in sales.

5. The proportion in which a multi product company sells its products is
referred to as sales mix. Companies involved in selling two or more
products try to sell their products in a proportion or mix that maximizes
their total profit.
Usually, different products have different sales prices, variable
expenses and contribution margin. Therefore, any change in
proportion in which the products are sold has significant impact on the
break-even point. This change is known as ‘change in sales mix’ or
‘shift in sales mix
Example:
The NORAN company sells two products; product X and product Y.
The information about sales price, variable expenses per unit and total
fixed expenses is given below:
Product X Product Y
Sales price $50 per unit $100 per unit
Variable expenses $30 per unit $ 40 per unit
The total monthly fixed expenses of the company are $270,000.
The company wants to generate a sales revenue of $1,000,000 in the
next month. To obtain this goal the company has the following options:
(i). Sell 6,000 units of product X and 7,000 units of product Y.
(ii). Sell 14,000 units of product X and 3,000 units of product Y.

6. 1). If option (i) is selected:
NORAN Company
Contribution margin income Statement
For the month of August 2014
Product X Product Y total
Sales $ 300,000 $ 700,000 $1,000,000
Less variable expenses $ 180,000 $ 280,000 $ 460,000
Contribution margin $ 120,000 $ 420,000 $ 540,000
Less fixed expenses $ 270,000
Net operating income $ 270,000
Break-even point = Total fixed expenses
Overall Contribution margin Ratio
= $270,000
.54
= $500,000

7. 2). If option (ii) is selected:
NORAN Company
Contribution margin income Statement
For the month of August 2014
Product X Product Y total
Sales $ 700,000 $ 300,000 $1,000,000
Less variable expenses $ 420,000 $ 120,000 $ 540,000
Contribution margin $ 280,000 $ 180,000 $ 460,000
Less fixed expenses $ 270,000
Net operating income $ 190,000
Break-even point = Total fixed expenses
Overall Contribution margin Ratio
= $270,000
.46
= $586,957

8. NORAN Company
Contribution margin income Statement
For the month of August 2014
Product X Product Y total
Sales $ 410,870 100% $ 176,087 100% $ 586,957 100%
- VE $ 246,522 60% $ 70,435 40% $ 316,957 54%
CM $ 164,348 40% $ 105,652 60% $ 270,000 46%
-FE $ 270,000
EBIT $ -
Product X Product Y total
SALES 700,000 300,000 1,000,000
% OF SALES 70% 30% 100%
SALES AT BEP 410,870 176,087 586,957

9. THANK YOU