# Variable Cost and Contribution Margin Ratio

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C V P Analysis

1

CVP Analysis
Understand how cost behavior and cost-volume-profit analysis are used by managers.

2

Analysis
 How much must I sell to earn my desired income?
 How will income be affected if I reduce selling prices to increase sales volume?  What will happen to profitability if I expand capacity?

3

Cost-Profit-Volume Analysis
 What is cost-volume-profit analysis?
It is the study of the effects of output volume on revenue (sales), expenses
(costs), and net income (net profit).

4

Variable Costs

Fixed Costs

Mixed Costs

Cost Estimation Methods
Cost Estimation Methods are frequently required to separate the fixed and variable components of a total cost pool. Methods include: 1.
2.
1. Contribution Margin Approach (used for similar products).
2. Contribution Margin Ratio Approach
(used for substantially different products). Contribution Margin Approach
Example: the contribution margin of product
A is \$8 and B is \$5. Two units of B are sold for each unit of A. The Weighted Average
Contribution Margin is \$6.00.

Contribution Margin Ratio
Approach
Example: the contribution margin ratio of product A is 20% and B is 50%. Two units of B are sold for each unit of A. The
Weighted Average Contribution Margin
Ratio is 40%.

Assumptions in C-V-P Analysis
1. Costs can be accurately separated into variable and fixed components.
2. Fixed costs remain fixed.
3. Variable costs per unit do not change over the relevant range.

Operating Leverage
Example of Operating Leverage:
Firm 1
Firm 2
Sales
\$10,000,000
\$10,000,000
VC
5,000,000
7,000,000
CM
5,000,000
3,000,000
FC
3,000,000
1,000,000
Profit
\$2,000,000
\$2,000,000
Which firm has more?

Constraints
1. A reference to scarce resources.
2. Examples of constraints include manufacturing space, labor, parts and materials etc..
3. The focus shifts away from Contribution
Margin and to the scarce resource or constraint. Quick Review Question #1
1. At Winford Corp., the selling price per unit for lawn mowers is \$120, variable cost per unit is \$55. Fixed costs are
\$130,000. Contribution Margin per unit is? a. \$65
b. \$75
c. \$175
d. \$30