CHAPTER 4:

Cost-Volume-
Profit
Relationships

Prepared by
Shannon Butler,
CPA, CA
Carleton
University
 Learning Objectives Part 1
1 Explain how changes in activity affect
contribution margin and operating income.
2 Prepare and interpret a cost–volume–profit
graph.
3 Calculate the contribution margin ratio and the
variable expense ratio. Use the contribution margin
ratio to compute changes in contribution margin
and operating income resulting from changes in
sales volume.
4 Show the effects on contribution margin of
changes in variable costs, fixed costs, selling price,
and volume.
© 2021 McGraw-Hill Limited 4-2
 Learning Objectives Part 2
5 Compute the break-even point in unit sales and
sales dollars.
6 Determine the level of sales needed to achieve a
desired target profit.
7 Compute the margin of safety and explain its
significance.
8 Explain cost structure, compute the degree of
operating leverage at a particular level of sales,
and explain how operating leverage can be used to
predict changes in operating income.

© 2021 McGraw-Hill Limited 4-3

 Learning Objectives Part 3

9 Compute the break-even point for a multi-

product company and explain the effects of
changes in the sales mix on the contribution
margin and the break-even point.

10 (Online Appendix 4A) Conduct a cost–

volume–profit analysis with uncertainty.

© 2021 McGraw-Hill Limited 4-4

Cost-Volume-Profit Relationship
Interactions
• Cost-volume-profit (CVP) analysis is a powerful
tool that managers use to help them understand
the interrelationship among cost, volume and
profit in an organization by focusing on
interactions among the following five elements:
1.prices of products
2.volume or level of activity
3.per unit variable costs
4.total fixed costs
5.mix of products sold
© 2021 McGraw-Hill Limited 4-5
 Basics of Cost-Volume-Profit
Analysis
The contribution income statement is helpful to managers
in judging the impact on profits of changes in selling price,
cost, or volume. The emphasis is on cost behaviour.
Example Company
Contribution Income Statement
For the Month of June
Sales (500 units) $ 250,000
Less: Variable expenses 150,000
Contribution margin 100,000
Less: Fixed expenses 80,000
Net operating income $ 20,000

Contribution Margin (CM) is the amount remaining from

sales revenue after variable expenses have been deducted.
© 2021 McGraw-Hill Limited 4-6
 Contribution Margin (CM)
Sales, variable expenses, and contribution margin can also
be expressed on a per unit basis. If an additional unit is
sold, $200 additional CM will be generated to cover fixed
expenses and profit.

Example Company
Contribution Income Statement
For the Month of June
Total Per Unit % of Sales
Sales (500 units) $ 250,000 $ 500 100%
Less: Variable expenses 150,000 300 60%
Contribution margin 100,000 $ 200 40%
Less: Fixed expenses 80,000
Net operating income $ 20,000

© 2021 McGraw-Hill Limited 4-7

 Contribution Margin Ratio

The CM ratio is calculated by dividing the total

contribution margin by total sales.
Example Company
Contribution Income Statement
For the Month of June
Total Per Unit CM Ratio
Sales (500 units) $ 250,000 $ 500 100%
Less: Variable expenses 150,000 300 60%
Contribution margin 100,000 $ 200 40%
Less: Fixed expenses 80,000
Net operating income $ 20,000

CM per unit $200

CM Ratio = = = 40%
SP per unit $500
© 2021 McGraw-Hill Limited 4-8
 The Contribution Approach 1

Each month, $80,000 in total CM must be

generated to break even.
Example Company
Contribution Income Statement
For the Month of June
Total Per Unit CM Ratio
Sales (500 units) $ 250,000 $ 500 100%
Less: Variable expenses 150,000 300 60%
Contribution margin 100,000 $ 200 40%
Less: Fixed expenses 80,000
Net operating income $ 20,000

© 2021 McGraw-Hill Limited 4-9

 The Contribution Approach 2
‫ﻧﻘطﮫ ﺳر ﺑﮫ ﺳر ﺗوﻟﯾد=زﻣﺎﻧﯽ ﮐﮫ ﺳود ﺧﺎﻟص ﻋﻣﻠﯾﺎﺗﯽ ﻣﺳﺎوی ﺻﻔر اﺳت‬

If 400 units are sold in a month, they will be

operating at the break-even point.
Example Company
Contribution Income Statement
For the Month of June
Total Per Unit CM Ratio
Sales ( 400 units) $ 200,000 $ 500 100%
Less: Variable expenses 120,000 300 60%
Contribution margin 80,000 $ 200 40%
Less: Fixed expenses 80,000
Net operating income $ -

Net income operating income=0 ---> operating at the break-even point

‫ﻧﻘطﮫ ﺳر ﺑﮫ ﺳر‬
© 2021 McGraw-Hill Limited 4-10
 The Contribution Approach 3
‫ دﻻر ﺳود ﺧﺎﻟص ﻋﻣﻠﯾﺎﺗﯽ ﻣﯾﺷﮫ‬200 ‫ واﺣد اﻓزاﯾش ﺳﺑب‬1 ‫ھر‬

If one more unit is sold (401 units), net

operating income will increase by $200.
Example Company
Contribution Income Statement
For the Month of June
Total Per Unit CM Ratio
Sales ( 401 units) $ 200,500 $ 500 100%
Less: Variable expenses 120,300 300 60%
Contribution margin 80,200 $ 200 40%
Less: Fixed expenses 80,000
Net operating income $ 200

© 2021 McGraw-Hill Limited 4-11

 The Contribution Approach 4
• We do not need to prepare an income
statement to estimate profits at a particular
sales volume. Simply multiply the number
of units sold above break-even by the
contribution margin per unit.
• If 430 units are sold, the net operating
income will be $6,000
• 30 units above break-even: 30 x 200 =
$6,000
© 2021 McGraw-Hill Limited 4-12
 CVP Relationships in
Graphic Form
• Relationships among revenue, cost, profit and volume
can be expressed graphically by preparing a CVP
graph. Below is a contribution margin income
statement at 300, 400, and 500 units sold. We will use
this information to prepare the CVP graph.

Income Income Income

300 units 400 units 500 units
Sales $ 150,000 $ 200,000 $ 250,000
Less: variable expenses 90,000 120,000 150,000
Contribution margin $ 60,000 $ 80,000 $ 100,000
Less: fixed expenses 80,000 80,000 80,000
Net operating income $ (20,000) $ - $ 20,000

© 2021 McGraw-Hill Limited 4-13

 CVP Graph 1
450,000

400,000

350,000

300,000
Dollars

250,000

200,000
In a CVP graph, unit volume is
150,000
usually represented on the
horizontal (X) axis and dollars on
100,000
the vertical (Y) axis.
50,000

-
- 100 200 300 400 500 600 700 800

Units

© 2021 McGraw-Hill Limited 4-14

 CVP Graph 2
450,000

400,000

350,000 Total Sales

300,000
Dollars

250,000
Total Expenses
200,000

150,000
Fixed Expenses
100,000

50,000

-
- 100 200 300 400 500 600 700 800

Units

© 2021 McGraw-Hill Limited 4-15

 CVP Graph 3
450,000

400,000
Break-even point
(400 units or $200,000 in sales)
350,000

300,000
Dollars

250,000

200,000

150,000

100,000

50,000

-
- 100 200 300 400 500 600 700 800

Units

© 2021 McGraw-Hill Limited 4-16

 Contribution Margin Ratio 1
• The contribution margin ratio is:
Total CM
CM Ratio =
Total sales

• For Example Company the ratio is:

$80,000
= 40%
$200,000
• Each $1.00 increase in sales results in a
total contribution margin increase of 40¢.
© 2021 McGraw-Hill Limited 4-17
Contribution Margin Ratio 2
• Or, in terms of units, the contribution
margin ratio is:

Unit CM
CM Ratio =
Unit selling price

• For Example Company the ratio is:

$200 = 40%
$500

© 2021 McGraw-Hill Limited 4-18

Contribution Margin Ratio 3
If sales increase from 400 to 500 units
($50,000), contribution margin will increase by
$20,000 ($50,000 × 40%). Here is the proof:

400 Units 500 Units

Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net operating income $ - $ 20,000

A $50,000 increase in sales revenue results in a $20,000

increase in CM ($50,000 × 40% = $20,000).
© 2021 McGraw-Hill Limited 4-19
 Contribution Margin Ratio 4
• The effect of a change in sales revenue on the
change in CM dollars can be expressed in
equation form as follows:

Change in CM dollars =
CM Ratio x Change in sales revenue

© 2021 McGraw-Hill Limited 4-20

 Quick Check 

Coffee Klatch is an espresso stand in a downtown office

building. The average selling price of a cup of coffee is $1.49
and the average variable expense per cup is $0.36. The
average fixed expense per month is $1,300. 2,100 cups are
sold each month on average. What is the CM Ratio for Coffee
Klatch?
a. 1.319
b. 0.758
c. 0.242
d. 4.139

© 2021 McGraw-Hill Limited 4-21

 Quick Check 

Coffee Klatch is an espresso stand in a downtown office

building. The average selling price of a cup of coffee is $1.49
and the average variable expense per cup is $0.36. The
average fixed expense per month is $1,300. 2,100 cups are
sold each month on average. What is the CM Ratio for Coffee
Klatch?

Answer:
b. 0.758

© 2021 McGraw-Hill Limited 4-22

 Variable Expense Ratio
Variable expense ratio is the ratio of variable
expenses to sales:
Variable expense ratio = Variable expenses / Sales
This leads to a useful equation that relates the CM
ratio to the variable expense ratio as follows:
CM ratio = CM / Sales
CM ratio = (Sales – Variable expenses) / Sales
CM ratio = 1 – Variable expense ratio

© 2021 McGraw-Hill Limited 4-23

Change in Fixed Cost and Sales
Volume 1

• What is the profit impact if sales can

increase from 500 units to 540 units by
increasing the monthly advertising
budget by $10,000?

advertising budget----> add to fixed cost

© 2021 McGraw-Hill Limited 4-24

Change in Fixed Cost and Sales
Volume 2
$80,000 + $10,000 advertising = $90,000
Example Company
Contribution Income Statement
For the Month of June
Current Sales Projected Sales
(500 units) (540 units)
Sales revenue $250,000 $270,000
Less: Variable expenses 150,000 162,000
Contribution Margin 100,000 108,000
Less: Fixed expenses 80,000 90,000
Net Income 20,000 18,000

Sales increased by $20,000, but net operating income

decreased by $2,000.
© 2021 McGraw-Hill Limited 4-25
Change in Fixed Cost and Sales
Volume 3

The CM Solution:

Increase in CM (40 units x $200) $ 8,000

Increase in advertising expenses (10,000)
Decrease in net operating income (2,000)

© 2021 McGraw-Hill Limited 4-26

 Change in Variable Cost and
Sales Volume 1

• What is the profit impact if a higher

quality of raw materials is used, thus
increasing variable costs per unit by
$10, to generate an increase in unit
sales from 500 to 580?
IF WE HAVE SAME UNIT NUMBERS, AFTER INCREASINGVARIABLE COST,
the contribution margin will decrease

© 2021 McGraw-Hill Limited 4-27

Change in Variable Cost and
Sales Volume 2
580 units × $310 variable cost/unit = $179,800
Example Company
Contribution Income Statement
For the Month of June
Current Sales Projected Sales
(500 units) (580 units)
Sales revenue $250,000 $290,000
Less: Variable expenses 150,000 179,800
Contribution Margin 100,000 110,200
Less: Fixed expenses 80,000 80,000
Net Income 20,000 30,200

Sales increase by $40,000, and net operating income

increases by $10,200.
© 2021 McGraw-Hill Limited 4-28
 Change in Variable Cost and
Sales Volume 3

The CM Solution:

Increase in VC of $10 x 500 units $ (5,000)

Increase in units sold:
80 units x 190 [200 – 10] 15,200
Decrease in net operating income 10,200

© 2021 McGraw-Hill Limited 4-29

Change in Fixed Costs, Selling
Price and Sales Volume 1

• What is the profit impact if:

(1) selling price is cut by $20 per
unit,
(2) the advertising budget is
increased by $15,000 per month, and
(3) sales increase from 500 to 650
units per month?

© 2021 McGraw-Hill Limited 4-30

Change in Fixed Costs, Selling
Price and Sales Volume 2
Example Company
Contribution Income Statement
For the Month of June
Current Sales Projected Sales
(500 units) (650 units)
Sales revenue $250,000 $312,000
Less: Variable expenses 150,000 195,000
Contribution Margin 100,000 117,000
Less: Fixed expenses 80,000 95,000
Net Income 20,000 22,000

Sales increase by $62,000, fixed costs increase by

$15,000, and net operating income increases by $2,000.
© 2021 McGraw-Hill Limited 4-31
Change in Fixed Costs, Selling
Price and Sales Volume 3
The CM Solution:

Decrease in Selling Price of

$20 x 500 units $(10,000)
Increase in advertising by
$15,000/month (15,000)
Increase in sales by
150 units x $180 [200-20] 27,000
Increase in net operating income 2,000
© 2021 McGraw-Hill Limited 4-32
Change in Variable Cost, Fixed
Cost and Sales Volume 1

• What is the profit impact if:

(1) instead of paying
salespersons flat salaries that
currently total $6,000 per month,
a $15 sales commission per unit
sold is paid, and
(2) sales increase from 500 units
to 575 units?
© 2021 McGraw-Hill Limited 4-33
Change in Variable Cost, Fixed
Cost and Sales Volume 2
Example Company
Contribution Income Statement
For the Month of June
Current Sales Projected Sales
(500 units) (575 units)
Sales revenue $250,000 $287,500
Less: Variable expenses 150,000 181,125
Contribution Margin 100,000 106,375
Less: Fixed expenses 80,000 74,000
Net Income 20,000 32,375

Sales increase by $37,500, variable costs increase by

$31,125, but fixed expenses decrease by $6,000. Net
operating income increased by $12,375.
© 2021 McGraw-Hill Limited 4-34
Change in Variable Cost, Fixed
Cost and Sales Volume 3

The CM Solution:

Increase in VC of $15 x 500 units $(7,500)

Increase in CM of
$185 [200-15] x 75 units 13,875
Decrease (savings) in FC 6,000
Increase in net operating income 12,375

© 2021 McGraw-Hill Limited 4-35

 Break-Even Analysis 1

• Break-even analysis is an aspect of

CVP analysis that is designed to
answer questions such as how far
sales could drop before the
company begins to lose money.

© 2021 McGraw-Hill Limited 4-36

 Break-Even Analysis 2

The contribution format income statement

can be stated in equation form:
Profits = (Sales – Variable expenses) – Fixed expenses
OR

Profits = [P x Q] – [V x Q] - Fixed expenses

Where P = selling price per unit, Q = number of

units sold; and VC = variable costs per unit.

© 2021 McGraw-Hill Limited 4-37

 Break-Even Analysis 3

Profits = [P x Q] – [V x Q] - Fixed expenses

We can simplify the above formula:

Profits = [CM x Q] – Fixed expenses

The Break-even point is when profits are

zero, therefore the equation becomes:
Break-even point in units sold = Fixed expenses
Unit CM

© 2021 McGraw-Hill Limited 4-38

 Break-Even Analysis 4

Break-even point in units sold = Fixed expenses

Unit CM
A variation of the break-even formula using
the CM ratio instead of the unit CM is
shown below. The result using this
formula is the break-even in total sales
dollars rather than in total units sold:
Break-even point in = Fixed expenses
Total sales dollars CM ratio
© 2021 McGraw-Hill Limited 4-39
 Break-Even Analysis 5

• Here is the information from Example

Company:

Total Per Unit Percent

Sales (500 units) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
Net operating income $ 20,000

© 2021 McGraw-Hill Limited 4-40

 Break-Even Analysis 6

We calculate the break-even point as follows:

Break-even point in units sold = Fixed expenses
Unit CM
= $80,000 / 200
= 400 units

Break-even point in
total sales dollars = Fixed expenses
CM ratio
= $80,000 / 40%
= $200,000
© 2021 McGraw-Hill Limited 4-41
 Quick Check 
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the average
variable expense per cup is $0.36. The average
fixed expense per month is $1,300. 2,100 cups
are sold each month on average. What is the
break-even sales in units?
a. 872 cups
b. 3,611 cups
c. 1,200 cups
d. 1,150 cups
© 2021 McGraw-Hill Limited 4-42
 Quick Check 
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the average
variable expense per cup is $0.36. The average
fixed expense per month is $1,300. 2,100 cups
are sold each month on average. What is the
break-even sales in units?

Answer:
d. 1,150 cups

© 2021 McGraw-Hill Limited 4-43

 Quick Check 
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a
cup of coffee is $1.49 and the average variable
expense per cup is $0.36. The average fixed
expense per month is $1,300. 2,100 cups are sold
each month on average. What is the break-even
sales in dollars?
a. $1,300
b. $1,715
c. $1,788
d. $3,129
© 2021 McGraw-Hill Limited 4-44
 Quick Check 
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the average
variable expense per cup is $0.36. The average
fixed expense per month is $1,300. 2,100 cups
are sold each month on average. What is the
break-even sales in dollars?

Answer:
b. $1,715

© 2021 McGraw-Hill Limited 4-45

Target Operating Profit Analysis 1

• CVP formulas can also be used to

determine
• the sales volume needed to achieve a target
operating profit.
• The dollar sales needed to achieve a target
operating profit.

• Suppose Example Company wants to know

how many units must be sold to earn a
profit of $100,000.

© 2021 McGraw-Hill Limited 4-46

Target Operating Profit Analysis 2

‫ﺗﻌداد ﻓروش ﺑرای رﺳﯾدن ﺑﮫ ﺳود ھدف‬

Units sold to attain Fixed expenses + Target operating profit

=
the target profit Unit contribution margin

$80,000 + $100,000
= 900 units
$200/unit

© 2021 McGraw-Hill Limited 4-47

Target Operating Profit Analysis 3
‫ﻣﺑﻠﻎ ﻓروش ﻣورد ﻧﯾﺎز ﺑرای رﺳﯾدن ﺑﮫ ﺳود ھدف‬

Dollar sales to Fixed expenses + Target operating profit

=
attain target profit CM Ratio

$80,000 + $100,000
= $450,000
40%

© 2021 McGraw-Hill Limited 4-48

 Quick Check 
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the average
variable expense per cup is $0.36. The average
fixed expense per month is $1,300. How many
cups of coffee would have to be sold to attain
target profits of $2,500 per month?
a. 3,363 cups
b. 2,212 cups
c. 1,150 cups
d. 4,200 cups
© 2021 McGraw-Hill Limited 4-49
 Quick Check 
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the average
variable expense per cup is $0.36. The average
fixed expense per month is $1,300. How many
cups of coffee would have to be sold to attain
target profits of $2,500 per month?

Answer:
a. 3,363 cups

© 2021 McGraw-Hill Limited 4-50

 After-Tax Analysis 1

• For-profit organizations are required to

pay corporate income taxes.
• In general, operating profit after taxes
can be computed as a fixed percentage
of income before taxes.

© 2021 McGraw-Hill Limited 4-51

 After-Tax Analysis 2

Profit after taxes = Before-tax profit – Taxes

= B – t(B)
= B(1-t)

Rearranged to calculate before-tax profit (B):

B = Profit after taxes / (1-t)

© 2021 McGraw-Hill Limited 4-52

 The Margin of Safety 1
The margin of safety is the excess of
budgeted (or actual) sales over the break-
even volume of sales.
Margin of safety = Total sales – Break-even sales

Margin of safety percentage =

Margin of safety in $
Total budgeted (or actual) sales
Let’s look at Example Company and
determine the margin of safety.
© 2021 McGraw-Hill Limited 4-53
 The Margin of Safety 2
If we assume that actual sales are $250,000, given
that we have already determined the break-
even sales to be $200,000, the margin of safety
is $50,000 as shown.
Break- Actual
even sales sales
400 units 500 units
Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net operating income $ - $ 20,000

© 2021 McGraw-Hill Limited 4-54

 The Margin of Safety 3

The margin of safety can be expressed as 20%

of sales. ($50,000 ÷ $250,000)

Break-even
sales Actual sales
400 units 500 units
Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net operating income $ - $ 20,000

© 2021 McGraw-Hill Limited 4-55

 The Margin of Safety 4

The margin of safety can be expressed in

terms of the number of units sold. The
margin of safety is $50,000, and each unit
sells for $500.

© 2021 McGraw-Hill Limited 4-56

 Quick Check 
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a
cup of coffee is $1.49 and the average variable
expense per cup is $0.36. The average fixed
expense per month is $1,300. 2,100 cups are sold
each month on average. What is the margin of
safety?
a. 3,250 cups
b. 950 cups
c. 1,150 cups
d. 2,100 cups
© 2021 McGraw-Hill Limited 4-57
 Quick Check 
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup
of coffee is $1.49 and the average variable
expense per cup is $0.36. The average fixed
expense per month is $1,300. 2,100 cups are sold
each month on average. What is the margin of
safety?

Answer:
b. 950 cups

© 2021 McGraw-Hill Limited 4-58

 Cost Structure and Profit
Stability 1

• Cost structure refers to the relative

proportion of fixed and variable costs
in an organization. Managers often
have some latitude in determining
their organization’s cost structure.

© 2021 McGraw-Hill Limited 4-59

 Cost Structure and Profit
Stability 2
There are advantages and disadvantages to high fixed
cost (or low variable cost) and low fixed cost (or high
variable cost) structures.
An advantage of a high fixed A disadvantage of a high fixed
cost structure is that income cost structure is that income
will be higher in good years will be lower in bad years
compared to companies compared to companies
with lower proportion of with lower proportion of
fixed costs. fixed costs.

Companies with low fixed cost structures enjoy greater

stability in income across good and bad years.
© 2021 McGraw-Hill Limited 4-60
 Operating Leverage 1
A measure of how sensitive net operating income
is to percentage changes in sales.

Degree of Contribution margin

=
operating leverage Operating income

% change in
=
operating income
Degree of Op. Leverage x % change in sales

© 2021 McGraw-Hill Limited 4-61

 Operating Leverage 2

Example Company, the degree of operating

leverage is 5:
Actual sales
500 Units
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 80,000
Net income $ 20,000

$100,000 = 5
$20,000
© 2021 McGraw-Hill Limited 4-62
 Operating Leverage 3
With an operating leverage of 5, if sales are
increased by 10%, net operating income would
increase by 50%.

Percent increase in sales 10%

Degree of operating leverage × 5
Percent increase in profits 50%

Here’s the verification!

© 2021 McGraw-Hill Limited 4-63

 Operating Leverage 4
Actual Increased
sales sales (550)
Sales $ 250,000 $ 275,000
Less variable expenses 150,000 165,000
Contribution margin 100,000 110,000
Less fixed expenses 80,000 80,000
Net operating income $ 20,000 $ 30,000

10% increase in sales from

$250,000 to $275,000 . . .

. . . results in a 50% increase in

income from $20,000 to $30,000.
© 2021 McGraw-Hill Limited 4-64
 Quick Check 
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the
average variable expense per cup is $0.36.
The average fixed expense per month is
$1,300. 2,100 cups are sold each month on
average. What is the operating leverage?
a. 2.21
b. 0.45
c. 0.34
d. 2.92
© 2021 McGraw-Hill Limited 4-65
 Quick Check 
Actual sales
Coffee Klatch is an espresso stand in a cups
2,100
downtown office building. The average 3,129
Sales selling
price of a cupLess:
of coffee is $1.49
Variable and the 756
expenses
average variable expense
Contribution per cup is $0.36.
margin 2,373
The average fixed expense
Less: Fixed per month is
expenses 1,300
$1,300. 2,100 Net
cups are sold
operating each month1,073
income on
average. What is the operating leverage?

Answer:
a. 2.21

© 2021 McGraw-Hill Limited 4-66

 Quick Check 
At Coffee Klatch the average selling price of a cup
of coffee is $1.49, the average variable expense
per cup is $0.36, the average fixed expense per
month is $1,300 and an average of 2,100 cups are
sold each month.
If sales increase by 20%, by how much should net
operating income increase?
a. 30.0%
b. 20.0%
c. 22.1%
d. 44.2%

© 2021 McGraw-Hill Limited 4-67

 Quick Check 
At Coffee Klatch the average selling price of a cup
of coffee is $1.49, the average variable expense
per cup is $0.36, the average fixed expense per
month is $1,300 and an average of 2,100 cups are
sold each month.
If sales increase by 20%, by how much should net
operating income increase?
Percent increase in sales 20.0%
Answer: × Degree of operating leverage 2.21
d. 44.2% Percent increase in profit 44.20%

© 2021 McGraw-Hill Limited 4-68

 Verify Increase in Profit
Actual Increased
sales sales
2,100 cups 2,520 cups
Sales $ 3,129 $ 3,755
Less: Variable expenses 756 907
Contribution margin 2,373 2,848
Less: Fixed expenses 1,300 1,300
Net operating income $ 1,073 $ 1,548
% change in sales 20.0%
% change in net operating income 44.2%

© 2021 McGraw-Hill Limited 4-69

 Sales Mix
• Sales mix is the relative proportion in
which a company’s products are sold.
• Different products have different selling
prices, cost structures, and contribution
margins.
• Let’s assume Example Company sells
bikes and carts and that the sales mix
between the two products remains the
same.
© 2021 McGraw-Hill Limited 4-70
Sales Mix & Break-Even Analysis 1
Example Co. information:

$265,000
= 48.2% (rounded)
$550,000
© 2021 McGraw-Hill Limited 4-71
Sales Mix & Break-Even Analysis 2

© 2021 McGraw-Hill Limited 4-72

 Assumptions of CVP Analysis
• Selling price is constant.
• Costs are linear and can be accurately divided into
variable (constant per unit) and fixed (constant in
total) elements.
• Variable costs per unit are constant, and fixed costs
are constant in total over the entire relevant range.
• In multiproduct companies, the sales mix is
constant.
• In manufacturing companies, inventories do not
change (units produced = units sold).

© 2021 McGraw-Hill Limited 4-73

End of Chapter Summary Part 1
• Cost–volume–profit (CVP) analysis is based on a
simple model of how contribution margin (CM)
and operating income respond to changes in
selling prices, costs, and volume.
• A CVP graph depicts the relationships between
sales volume in units and fixed expenses,
variable expenses, total expenses, total sales,
and profits.

© 2021 McGraw-Hill Limited 4-74

End of Chapter Summary Part 2
• The CM ratio is the ratio of the total CM to total
sales. This ratio can be used to estimate the
effect of a change in total sales on operating
income.
• The break-even point is the level of sales (in
units or in dollars) at which the company
generates zero profits.
• The margin of safety is the amount by which the
company’s current sales exceed break-even
sales.
© 2021 McGraw-Hill Limited 4-75
End of Chapter Summary Part 3
• The degree of operating leverage measures the
effect of a percentage change in sales on the
company’s operating income. The higher the
degree of operating leverage, the more sensitive
operating income will be to a change in sales.
• The profits of a multi-product company are
affected by its sales mix.

© 2021 McGraw-Hill Limited 4-76

 Cost-Volume-Profit
Analysis with Uncertainty
Appendix 4A

© 2021 McGraw-Hill Limited 4-77

 Cost-Volume-Profit Analysis
with Uncertainty
• Cost-volume-profit analysis is often used to assess
what future prospects might be under various
alternatives.
• Management can use data for various alternatives to
create a decision tree.
• Subjective probabilities represent what a manager
believes will occur and can also be put into the
decision tree to determine what the probability is of
each alternative.
• This information can also be used to estimate the
expected future profits.
© 2021 McGraw-Hill Limited 4-78
Chapter 4 Case
BSMM 8110 F2021
Break‐even, Target Profit Margin of Safety, CM Ratio
Menlo Company distributes a single product. The company’s sales
and expenses for last month:
Total Per Unit
Sales $450,000 $30
Variable Expenses 180,000 12
Contribution Margin $270,000 $18
Fixed Expenses 216.000
Operating Income $54,000
Break‐even, Target Profit Margin of Safety, CM Ratio
1. What is the monthly break‐even point in unit sales and in dollar sales?
2. Without resorting to calculations, what is the total contribution margin
at the break‐even point?
3. How many units would have to be sold each month to earn a target
profit of $90,000? Verify your answer by preparing a contribution
format income statement at the target sales level.
4. Refer to Part 3 and now assume that the tax rate is 30%. How many
units would need to be sold each month for an after‐tax profit of
$90,000?
5. Refer to the original data. Calculate the company’s margin of safety in
both dollar and percentage basis.
6. What is the company’s CM Ratio? If sales increase by $50,000 per
month and there is no change in fixed expenses, by how much would
you expect monthly net operating income to increase?
Break‐even, Target Profit Margin of Safety, CM Ratio
1. What is the monthly break‐even point in unit sales and in dollar
sales?
Break‐even, Target Profit Margin of Safety, CM Ratio

1. Unit sales to break-even:

Unit sales = Fixed expenses
to break even Unit contribution margin

$216,000
= = 12,000 units
$18
or at $30 per unit, $360,000
Break‐even, Target Profit Margin of Safety, CM Ratio
2. Without resorting to calculations, what is the total contribution
margin at the break‐even point?
Break‐even, Target Profit Margin of Safety, CM Ratio
2. The contribution margin is $216,000 because the
contribution margin is equal to the fixed expenses at the
break-even point.
Break‐even, Target Profit Margin of Safety, CM Ratio
3. How many units would have to be sold each month to earn a
target profit of $90,000? Verify your answer by preparing a
contribution format income statement at the target sales level.
Break‐even, Target Profit Margin of Safety, CM Ratio
3.
Break‐even, Target Profit Margin of Safety, CM Ratio

3.
Units sold to attain = Target profit + Fixed expenses
target profit Unit contribution margin

$90,000 + $216,000
=
$18
= 17,000 units
Break‐even, Target Profit Margin of Safety, CM Ratio

Total Unit
Sales (17,000 units × $30 per unit) ....... $510,000 $30
Variable expenses
(17,000 units × $12 per unit) ............. 204,000 12
Contribution margin.............................. 306,000 $18
Fixed expenses .................................... 216,000
Net operating income ........................... $ 90,000
Break‐even, Target Profit Margin of Safety, CM Ratio
4. Refer to Part 3 and now assume that the tax rate is 30%. How
many units would need to be sold each month for an after‐tax profit
of $90,000?
Break‐even, Target Profit Margin of Safety, CM Ratio

4. Unit sales required to earn an after-tax profit of $90,000

Target after െ tax profit
Fixed expenses ൅
ൌ 1 െ Tax Rate
Unit Contribution Margin

$90,000
$216,000 ൅
ൌ 1 െ .3
$18
ൌ 19,143 units ሺroundedሻ
Break‐even, Target Profit Margin of Safety, CM Ratio
5. Refer to the original data. Calculate the company’s margin of
safety in both dollar and percentage basis.
Break‐even, Target Profit Margin of Safety, CM Ratio
5. Margin of safety in dollar terms:
Margin of safety = Total sales - Break-even sales
in dollars

= $450,000 - $360,000 = $90,000

Margin of safety in percentage terms:
Margin of safety = Margin of safety in dollars
percentage Total sales
$90,000
= = 20%
$450,000
Break‐even, Target Profit Margin of Safety, CM Ratio
6. What is the company’s CM Ratio? If sales increase by $50,000 per
month and there is no change in fixed expenses, by how much would
you expect monthly net operating income to increase?
 Break‐even, Target Profit Margin of Safety, CM Ratio
6. The CM ratio is 60%.

Expected total contribution margin: ($500,000 × 60%) .. $300,000

Present total contribution margin: ($450,000 × 60%)..... 270,000
Increased contribution margin ....................................... $ 30,000

Alternative solution:
$50,000 incremental sales × 60% CM ratio = $30,000

Given that the company’s fixed expenses will not change, monthly net
operating income will also increase by $30,000.
Multi‐Product Break‐Even Analysis
Gogan Company manufactures and sells two products: Basic
and Deluxe. Monthly sales, CM ratios, and the CM per unit for
the two products are shown below:

Product
Basic Deluxe Total
Sales $600,000 $400,000 $1,000,000
CM Ratio 60% 35% ?
CM per unit $9.00 $11.50 ?
The company’s fixed expenses total $400,000 per month.
Multi‐Product Break‐Even Analysis
Required:
1. Prepare a contribution format income statement for the
company as a whole.
2. Calculate the overall break‐even point in dollars for the company
based on the current sales mix.
3. Calculate the overall break‐even point in units for the company
based on the current sales mix.
4. If sales increase by $50,000 per month, by how much would you
expect the operating income to increase? What are your
assumptions?
5. If sales increase by 5,000 units per month, by how much would
you expect the operating income to increase? What are your
assumptions?
Multi‐Product Break‐Even Analysis
1. Prepare a contribution format income statement for the
company as a whole.
Multi‐Product Break‐Even Analysis

*$500,000 ÷ $1,000,000 = 50%.

Multi‐Product Break‐Even Analysis
2. Calculate the overall break‐even point in dollars for the
company based on the current sales mix.
Multi‐Product Break‐Even Analysis
Multi‐Product Break‐Even Analysis
3. Calculate the overall break‐even point in units for the
company based on the current sales mix.
 Multi‐Product Break‐Even Analysis
3. The break-even point in units for the company as a whole would be:

(1) (2) (3)

(1) X (2)
Current Weighted
Monthly Sales CM per Average CM
Products Sales in Units* Mix** unit Per Unit
Basic 40,000 .767 $9.00 $6.90
Deluxe 12,173 .233 $11.50 2.68
Total 52,173 $9.58
*Basic: $600,000  ($9  .60); Deluxe: $400,000  ($11.50  .35)
**Basic: 40,000  52,173; Deluxe: 12,173  52,173
Multi‐Product Break‐Even Analysis
Multi‐Product Break‐Even Analysis
4. If sales increase by $50,000 per month, by how much would
you expect the operating income to increase? What are your
assumptions?
Multi‐Product Break‐Even Analysis
Multi‐Product Break‐Even Analysis
5. If sales increase by 5,000 units per month, by how much
would you expect the operating income to increase? What are
your assumptions?
 Multi‐Product Break‐Even Analysis

5. The additional contribution margin from additional sales of 5,000 units

can be computed as follows:
5,000 units × $9.58 per unit* = $47,900

*weighted average contribution margin from part 3 above.

This answer assumes no change in selling prices, variable costs per unit,
fixed expenses, or sales mix.