21 4.1: Introduction
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Last updated
- Dec 28, 2020
(unsplash license; Joshua Reddekopp via unsplash)
Recilia Vera is vice president of sales at Snowboard Company, a manufacturer of one model of snowboard. Lisa Donley is the company accountant. Recilia and Lisa are in their weekly meeting.
| Recilia: | Lisa, I’m in the process of setting up an incentive system for my sales staff, and I’d like to get a better handle on our financial information. |
| Lisa: | No problem. How can I help? |
| Recilia: | I’ve reviewed our financial results for the past 12 months. It looks like we made a profit in some months, and had losses in other months. From what I can tell, we sell each snowboard for $250, our variable cost is $150 per unit, and our fixed cost is $75 per unit. It seems to me that if we sell just one snowboard each month, we should still show a profit of $25, and any additional units sold should increase total profit. |
| Lisa: | Your unit sales price of $250 and unit variable cost of $150 look accurate to me, but I’m not sure about your unit fixed cost of $75. Fixed costs total $50,000 a month regardless of the number of units we produce. Trying to express fixed costs on a per unit basis can be misleading because it depends on the number of units being produced and sold, which changes each month. I can tell you that each snowboard produced and sold provides $100 toward covering fixed costs—that is, $250, the sales price of one snowboard, minus $150 in variable cost. |
| Recilia: | The $75 per unit for fixed costs was my estimate based on last year’s sales, but I get your point. As you know, I’d like to avoid having losses. Is it possible to determine how many units we have to sell each month to at least cover our expenses? I’d also like to discuss what it will take to make a decent profit. |
| Lisa: | We can certainly calculate how many units have to be sold to cover expenses, and I’d be glad to discuss how many units must be sold to make a decent profit. |
| Recilia: | Excellent! Let’s meet again next week to go through this in detail. |
Answering questions regarding break-even and target profit points requires an understanding of the relationship among costs, volume, and profit (often called CVP). This chapter discusses cost-volume-profit analysis1, which identifies how changes in key assumptions (for example, assumptions related to cost, volume, or profit) may impact financial projections. We address Recilia’s questions in the next section.
Definition
- The process of analyzing how changes in key assumptions (e.g., assumptions related to cost, volume, or profit) may impact financial projections.
