Cost, Volume, and Profit Formulas Essay
Cost, Volume, and Profit Formulas All businesses require becoming profitable or at some point they will fail. Accounting plays an essential role in determining if the company will become successful and continue to do so over time. Using well-defined formulas in order to assess the exact numbers will facilitate the actions a company needs to carry out in order to maintain its goals. The accounting department would look at the cost-volume-profit analysis to concentrate on the different components that change the profitability of any business.
The cost-volume-profit analysis consist of five components, these are: unit selling price, fixed cost per unit, sales mix, and volume activity. Each component plays a vital role and is just as important as the next although, each is dissimilar to the other. Volume activity can otherwise be known as sales activity, meaning the total of units sold. Whereas, the unit selling price is the number in which the unit is sold for. An example would consist of this; if four gallons of paint sold for a total of $100, that would mean that each can of paint cost per gallon.
Therefore, the unit selling price for each gallon of paint would be $25. The variable costs per unit are the expenses that are required in order to make the unit. This could include but is not limited to the changing costs of items such as raw materials and/or labor. The fixed cost per unit is similar to the variable costs per unit however; it does not change in costs. These are costs that can be presumed to stay the same throughout the year including fixed costs such as taxes and utilities.
Because most companies and retail stores carry different items at different prices there would be a blend of numbers in sales referred to as the sales mix. The formula for contribution margin per unit is expressed as: the unit selling price subtracted by the unit variable costs. Thus, an increase of the unit selling price would equal a higher contribution margin per unit. For example, if Hewlett Packard sold their copiers for $1100 a unit and its variable cost per unit is $600, the contribution per unit would be $500.
If Hewlett Packard were to sell their printers for $1200 a unit, that would thus, increase their contribution margin per unit to $600. When volume, or sales are higher while fixed costs remain the same, the cost per unit decreases. The volume of activity and fixed costs has an inverse relationship. An example could be, if Hewlett Packard has a fixed cost of $20,000 a month, and has manufactured 10,000 units, it would then equal in cost to $2 per unit. On the other hand, if Hewlett Packard were to increase the production to 20,000 units, it would then only cost $1 per unit.
The contribution ratio is used to find the break-even point, meaning when the company’s revenues equal out to the company’s total costs. Additionally, the contribution ratio figures where a company is running at a profitable area, and where its income exceeds its expenses. Furthermore, it figures how and when a company may be running at a loss of profit. The contribution margin is defined as the: contribution margin per unit divided by the units selling price. Additionally it may also be defined as: the unit selling price divided by the variable cost.
These two formulas are used to find the break-even point in dollars and are expressed as: fixed costs divided by unit contribution margin as well as fixed costs divided by unit contribution ratio. With each unit sold, it will increase earnings by the contribution margin. For every dollar in sales, it will increase earnings by the contribution ratio. Each of these figures is essential in analyzing the financial overview of any company. By decreasing costs per unit and increasing sales, a company has the potential to become a profitable business.
However, if the costs per unit are increased and sales volumes decrease, the company will not be able to maintain its operations. The ability to analyze costs will aid management to adapt to any significant changes in the way he, or she must run their business. Reference: Kieso, D. , Kimmel, P. , & Weygandt, J. (2003). Cost-Volume-Profit Relationships. Essentials of Accounting: Tools for Business Decision Making (2nd ed. ). Hoboken, NJ: John Wiley & Sons, Inc.