STRATEGIC COST MANAGEMENT
CM 2
1. The CVP Method
DEFINITION
The Cost Volume-Profit (CVP) analysis is a method used to analyze your costs and
plan for a reasonable profit. This tool can help you to answer the following
questions:
- How much output do I need to sell to recover my costs?
- At what point would each product sale create a profit?
- How much output must be sold to earn a specific profit?
CVP analysis helps you to perform strategic what-if analysis.
CONTRIBUTION MARGIN
Effective use of CVP requires an understanding of the Contribution Margin (marge
sur coûts variables)
The only numbers that change from selling different quantities of packages are
total revenues and total variable costs. The difference between total revenues ant
total variable costs is called contribution margin.
Contribution Margin= Sales Revenues – Total Variable Costs
Contribution Margin per unit= Selling price–Variable Cost Per Unit
Represents what you will earn for each unit increase in sale
Contribution Margin Percentage* = Contribution Margin/Revenues
Could be useful for companies selling multiple products
* Also called Contribution Ratio
Contribution Margin Rate = Contribution Margin / Sales Revenue
CVP RELATIONSHIPS (3 METHODS)
1/ Equation Method
Operating profit = Sales – Total Costs
= Sales – Variable Costs – Fixed Costs
= (Unit Sold * Selling Price Per Unit) – (Unit Sold * Variable
Cost Per Unit) – Fixed Costs
2/ Contribution Margin Method
Operating profit = (Unit Sold * Selling Price Per Unit) – (Unit Sold * Variable
Cost Per Unit) – Fixed Costs
= (Unit Sold*(Selling Price Per Unit – Variable Cost Per Unit)) –
Fixed
Costs
= (Unit Sold*Contribution Margin Per Unit) – Fixed Costs
3/ Graph Method
You have to plot lines representing total costs and total revenues according to
quantities sold
BREAK EVEN POINT (BEP)
The BEP is the quantity of output sold at which total revenues equal total costs.
Break even analysis allows to answer the question:
What’s the amount of output I need to sell to cover all of my costs?
In the example, the break-even point is $ 750,000
BEP formula
Operating profit = (Unit Sold * Selling Price Per Unit) – (Unit Sold * Variable
Cost Per Unit) – Fixed Costs
At break even, Operating profit = 0, so the equation becomes:
0 = Unit Sold * (Selling Price Per Unit – Variable Cost Per Unit) – Fixed Costs
Unit Sold To Reach Break Even = Fixed Costs/ Contribution Margin Per Unit
MARGIN/INDEX OF SAFETY
These data are more and more important today because of the uncertainty of the
global economy (crisis, change of customer behavior, etc.)
Margin of Safety = Total Sales – Break Even Point
Basically, how much the company can lose and still be safe
Index of Safety = Margin of Safety / Sales Revenue
2. Budget
A budget is a detailed plan for the acquisition and use of financial & other
resources over a specific period – yearly, monthly, quarterly, etc.
A budget includes both financial - revenues Vs expenses - and non-financial
information – for instance, how many employees you think you need.
Advantages – Budgets
o Promote coordination between the various departments of the
organization
o Enhance communication from top management to employees
o Is a motivating device if targets are demanding but achievable
o Is used as a performance assessment tool to review spending and
ensure you don’t exceed your budget spending.
Challenges – Budgets
o Budgeting Process is time consuming! A month-long exercise that
consumes to many resources
o Rigidity of the process: not an end in itself!
MASTER BUDGET
A Master Budget is a summary of financial budgets and operating budgets.
The operating budget begins with sales budget from which is derived Production
Budgets & Selling & Administrative Expense Budget. It concludes with the
Budgeted Income Statement
Financial budget = Budgeted Balance Sheet + Budgeted Cash Flow Statement
+ Capital Expenditures Budget + Cash Budget
COMPONENTS OF THE MASTER BUDGET
1/ Operating budget
- Sales budget shows forecasted sales in units & dollars for the upcoming
period
- Production budget: shows planned production for a given period
You need to know how many units you already have in inventory and how many
units you want on ending inventory. Then, you can compute your budgeted
production:
Units to produce = Sales Budget + Target Ending Inventory – Beginning
Inventory
Budgeted Production is then multiplied by cost per unit. Cost per unit is
composed of direct materials, direct labor and indirect costs (overhead)
Cost of goods manufactured, and cost of goods sold budgets are prepared next
2/ Financial budget
- Based on the operating budgets, you will be able to prepare the CAPEX
Budget, the Cash Budget, the Budgeted Balance Sheet and the
Budgeted Statement of Cash Flows.
- As they prepare operating budgets, managers do not focus only on what
they can achieve. They also identify the risks they face (ex: potential
decline in demand for the company’s products, the entry of a new
competitor, or an increase in the prices of different inputs, etc.)
- Sensitivity analysis is a useful tool that helps managers evaluate these
risks. Sensitivity analysis is a “what-if” technique that illustrates the impact
of changes from predicted data
Leverage effect = Contribution Margin / Operating Income
