Putting It Together: Cost-Volume-Profit-Analysis

A sailboat on the water with a sunset in the background.Contribution margin may be looked at from a variety of perspectives that often involve comparisons within different segments of a company. Data may be isolated by product, geographic area, salesperson, customer, distribution method, etc., and analyzed in terms of how individuals or entities within a segment perform in terms of contribution margin percentage. Managers may use these targeted results to discover strengths that may be capitalized on and/or weaknesses that may need to be addressed.

Let’s go back to Classic Boats, Inc. Your new boss handed you the following information for the month of July, compiled by the financial accounting staff:

Classic Boats, Inc.
Income Statement
For the month ending July 31, 20XX
Description Total
Sales $    156,000.00
Cost of Goods Sold $    122,000.00
Gross Profit Single Line$     34,000.00
Selling, general, and administrative costs $     34,680.00
Operating income Single Line$      (680.00)
Provision for income taxes $             –
Single Line$      (680.00)Double line

 

Her question to you was simple: Why are we losing money, and what do we have to do to make money?

She also noted that the company sold 26 custom sailboats in July at a price of $6,000 each.

By “data mining” through the accounting records, you come up with the following:

Hulls $2,000.00 each
Outfitting $1,000.00 each
Labor per assembled boat $1,500.00 each
Sales Salary $10,000.00 per month
Commission 3.00% each
Fixed costs $20,000.00 per month
Production facility rent $5,000.00 per month
Sales Price $6,000.00 each

 

Which you then sort into fixed and variable costs:

Subcategory, Variable Costs
Hulls $2,000.00
Outfitting $1,000.00
Labor per assembled boat $1,500.00
Commission $180.00
Single Line$4,680.00Double line
Subcategory, Fixed Costs
Sales Salary $10,000.00
Other fixed costs $20,000.00
Production facility rent $5,000.00
Single Line$35,000.00Double line

 

From that, you can recreate the financials using a variable costing model:

Classic Boats, Inc.
CVP Analysis
For the month ending July 31, 20XX
Units $/Unit Total
Sales 26 $      6,000.00 $     156,000.00
Variable costs 26 $      4,680.00 121,680.00
Contribution Margin $      1,320.00 Single Line34,320.00
Fixed costs       35,000.00
Operating income Single Line$       (680.00)Double line
CM ratio 22.00%

 

When you run your break-even analysis, you see that the sales are just below break-even, which is fairly obvious even without the CVP calculation:

Classic Boats, Inc.
CVP Analysis – break even
For the month ending July 31, 20XX
Units $/Unit Total
Sales 27 $      6,000.00 $     162,000.00
Variable costs 27 $      4,680.00 126,360.00
Contribution Margin $      1,320.00 Single Line35,640.00
Fixed costs       35,000.00
Operating income Single Line$       (640.00)Double line
CM ratio 22.00%

 

From here, you could run a sensitivity analysis to determine the effects of different assumptions. For instance, decreasing variable costs by a mere 1% results in the following:

Classic Boats, Inc.
Sensitivity Analysis – reduce variable costs by 1%
For the month ending July 31, 20XX
Units $/Unit Total
Sales 26 $      6,000.00 $   156,000.00
Variable costs 26 $      4,633.20 120,463.20
Contribution Margin $      1,366.80 Single Line35,536.80
Fixed costs       35,000.00
Operating income Single Line$       536.80Double line
      Increase (decrease) over base $     1,216.80
      % increase (decrease) over base N/A because base was negative
CM ratio 22.78%

 

As you can see, a variable costing model is extremely useful for managerial accountants in diagnosing problems and solutions, but it is only just a start. In this course, you will learn to use concepts and techniques like static and flexible budgets, standard costing with variance analysis, and responsibility accounting to further refine your skills in directing and controlling operations.

Contribution margin analysis is also useful for planning purposes. For each product, managerial accountants can forecast sales volume, unit selling price, unit variable cost of production, and unit variable cost of selling to estimate contribution margin. Subsequently, one or more of these four variables can be changed to show the impact on the contribution margin.

One final note: Variable costing may also be applicable to a service business, even though manufacturing costs are not involved. A small hotel, for example, earns revenue from renting rooms. Variable costs may include food and beverage expense for breakfast, supplies expense, selling expense, and an incremental utilities expense amount for times when rooms are occupied. Fixed costs of rent expense for the property, salaries expense, depreciation expense, and insurance expense are typical.