3.6: Summary and Key Terms
- Page ID
- 10425
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Section Summaries
3.1 Explain Contribution Margin and Calculate Contribution Margin per Unit, Contribution Margin Ratio, and Total Contribution Margin
- Contribution margin can be used to calculate how much of every dollar in sales is available to cover fixed expenses and contribute to profit.
- Contribution margin can be expressed on a per-unit basis, as a ratio, or in total.
- A specialized income statement, the Contribution Margin Income Statement, can be useful in looking at total sales and total contribution margin at varying levels of activity.
3.2 Calculate a Break-Even Point in Units and Dollars
- Break-even analysis is a tool that almost any business can use for planning and evaluation purposes. It helps identify a level of activity that is necessary before an organization starts to generate a profit.
- A break-even point can be found on a per-unit basis or as a dollar amount, depending upon whether a per-unit contribution margin or a contribution margin ratio is applied.
3.3 Perform Break-Even Sensitivity Analysis for a Single Product Under Changing Business Situations
- Cost-volume-profit analysis can be used to conduct a sensitivity analysis that shows what will happen if there are changes in any of the variables: sales price, units sold, variable cost per unit, or fixed costs.
- The break-even point may or may not be impacted by changes in costs depending on the type of cost affected.
3.4 Perform Break-Even Sensitivity Analysis for a Multi-Product Environment Under Changing Business Situations
- Companies provide multiple products, goods, and services to the consumer and, as result, need to calculate their break-even point based on the mix of the products, goods, and services.
- In a multi-product environment, calculating the break-even point is more complex and is usually calculated using a composite unit, which represents the sales mix of the business.
- If the sales mix of a company changes, then the break-even point changes, regardless of whether total sales dollars change or not.
3.5 Calculate and Interpret a Company’s Margin of Safety and Operating Leverage
- Businesses determine a margin of safety (sales dollars beyond the break-even point). The higher the margin of safety is, the lower the risk is of not breaking even and incurring a loss.
- Operating leverage is a measurement of how sensitive net operating income is to a percentage change in sales dollars. A high degree of operating leverage results from a cost structure that is heavily weighted in fixed costs.
Key Terms
- break-even point
- dollar amount (total sales dollars) or production level (total units produced) at which the company has recovered all variable and fixed costs; it can also be expressed as that point where Total Cost (TC) = Total Revenue (TR)
- composite unit
- selection of discrete products associated together in relation or proportion to their sales mix
- contribution margin
- amount by which a product’s selling price exceeds its total variable cost per unit
- contribution margin ratio
- percentage of a unit’s selling price that exceeds total unit variable costs
- margin of safety
- difference between current sales and break-even sales
- multi-product environment
- business environment in which a company sells different products, manufactures different products, or offers different types of services
- multiplier effect
- when the change in an input by a certain percentage has a greater effect (a higher percentage effect) on the output
- operating leverage
- measurement of how sensitive net operating income is to a percentage change in sales dollars
- relevant range
- quantitative range of units that can be produced based on the company’s current productive assets; for example, if a company has sufficient fixed assets to produce up to \(10,000\) units of product, the relevant range would be between \(0\) and \(10,000\) units
- sales mix
- relative proportions of the products that a company sells
- sensitivity analysis
- what will happen if sales price, units sold, variable cost per unit, or fixed costs change
- target pricing
- process in which a company uses market analysis and production information to determine the maximum price customers are willing to pay for a good or service in addition to the markup percentage
- total contribution margin
- amount by which total sales exceed total variable costs