Learning Outcomes
- Prepare a statement that shows a change in fixed cost and sales volume
Monday is not starting off well. The landlord of your building just called, and effective next month, your rent has increased by $200 a month. Net profit was already low and you are not sure how to approach your boss with this piece of information. You get out your CVP chart and get to work.
When the fixed costs change, it can also have a huge effect on profits. What if the space you are renting is all of a sudden $200 more per month that you were paying? Or maybe health insurance premiums for your employees double? These are situations that we sometimes cannot change or anticipate, but we need to know how to manage.
Let’s take a look at Monte Company when their rent goes up!
| Cost-Volume-Profit: BEFORE rent increase | |||||
|---|---|---|---|---|---|
| Monte Corporation | |||||
| Number Sold | 1 | 50 | 100 | 150 | 200 |
| Price per Item | $10 | $500 | $1,000 | $1,500 | $2,000 |
| Variable cost per item | $4 | $200 | $400 | $600 | $800 |
| Contribution Margin | $6 | $300 | $600 | $900 | $1,200 |
| Fixed Costs | $400 | $400 | $400 | $400 | $400 |
| Profit (loss) | ($394) | ($100) | $200 | $500 | $800 |
In this chart, they are still at $400 a month for fixed costs.
| Cost-Volume-Profit: AFTER rent increase | |||||
|---|---|---|---|---|---|
| Monte Corporation | |||||
| Number Sold | 1 | 50 | 100 | 150 | 200 |
| Price per Item | $10 | $500 | $1,000 | $1,500 | $2,000 |
| Variable cost per item | $4 | $200 | $400 | $600 | $800 |
| Contribution Margin | $6 | $300 | $600 | $900 | $1,200 |
| Fixed Costs | $600 | $600 | $600 | $600 | $600 |
| Profit (loss) | ($594) | ($300) | $0 | $300 | $600 |
Look what happens when their fixed costs go to $600 per month due to the rent increase! They used to show a net profit of $200 when they sold 100 widgets, and now they show no profit at all.
How can we adjust for this change in fixed costs?
- We can raise the price of our product to compensate for the increased expenses.
- We can try to source less expensive components for our widgets to lower our variable costs.
- We could move to a less expensive facility.
- We can work on increasing the sales of our product.
As a manager, you may need to make some difficult decisions. What would be your recommendations in this situation?
Practice Questions
