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3.0: Prelude to Cost-Volume-Profit Analysis

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  • As president of the Accounting Club, you are working on a fundraiser selling T-shirts on campus. You have gotten quotes from several suppliers ranging from \(\$8\) to \(\$10\) per shirt and now have to select a vendor. The prices vary based on whether the T-shirts have pockets, have long sleeves or short sleeves, and are printed on one side or both. You are confident that you can sell them for \(\$15\) each. However, the college charges clubs a \(\$100\) “student sale” fee, and your T-shirt sales must cover this cost and still net the club enough money to pay for your spring trip

    fig 3.0.1.jpg
    Figure \(\PageIndex{1}\): Balancing Cost, Volume, and Profit. Managers employ cost-volume-profit (CVP) analysis to determine the sales level at which they break even or balance their revenue with their expenses. (credit: modification of “Balance Swing Equality” by “Mediamodifier”/Pixabay, CC0)

    In addition, several of the vendors will give volume discounts—the more shirts you purchase, the less each shirt costs. In short, you need to know exactly which style of T-shirt, vendor, and quantity will allow you to reach your desired net income and cover your fixed expense of \(\$100\). You decide on a short-sleeve shirt with a pocket that costs \(\$10\) each and that you can sell for \(\$15\).

    This \(\$5\) per shirt “gross profit” will first go toward covering the \(\$100\) student sale fee. That means you will have to sell \(20\) shirts to pay the fee \(\left (\frac {\$ 100}{ \$ 5}=20 \text{  shirts} \right )\). After selling the first \(20\) shirts, the \(\$5\) profit will be available to start paying for the cost of the trip. Your faculty advisor has calculated that the trip will cost \(\$125\) per student, and you have \(6\) people signed up for the trip. This means the sale will need to generate an additional \(\$750\) from the sale (\(6\) students \(\times \$ 125\)). At \(\$5\) per shirt you will need to sell \(150\) shirts to cover the student costs \(\left (\frac {\$750}{\$5} \right )\). So, you will need to sell a total of \(170\) shirts: \(20\) to cover your fixed cost of \(\$100\) and an additional \(150\) to cover the student’s cost of the trip (\(\$750\)). What you have just completed is a cost-volume-profit analysis. In this chapter, we will explore how managers can use this type of analysis to make a wide range of decisions about their business operations.