Accounting Discussion #2 (part B/C)
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peers_discussion_posts.docxChoose and respond to 3 peers’ discussion posts. Each should be a minimum of 150-250 words.
Discussion #1 : Break-Even Analysis
What exactly is a break-even analysis? According to our textbook is defined as, ‘the level of sales at which profit is zero (Noreen, Brewer and Garrison, 2014).’ From another article on the topic I read for more clarification on the topic it states that the break-even analysis helps to show you when your business revenues equal your costs. So this is important for any business owner to be able to forecast costs and sales using a break-even analysis.
Therefore, a company will break-even when all its sales equals its total expenses. At this point, there is no loss or net gain made. This is important to any business owner to know, as it helps to calculate margins. The break-even analysis is in fact the lower limits of profit. Then you have to look at all the costs involved; there are fixed costs and variable costs.
Fixed costs includes any cost that are the same monthly regardless of how many units you sell. Fixed costs include all the rent, insurance fees, and start up costs. As these cost must be met to keep the business afloat. Now variable costs on the other hand, these are recurring costs that you pay for raw materials. For example, if I made organic raw jam to sell, this will include the costs of the blueberries; chia seeds and organic raw honey will fall under these variable costs.
Then you need to know about setting an appropriate price for your product. This is another valuable part of break-even analysis. You would not be able to calculate revenues if you do not know the basic unit price will be for each bottle of jam let’s say. So to factor in pricing there is two methods one can use wither cost-based pricing or priced-based costing.
Cost-based pricing, this encompasses what one bottle of jam or unit will cost to produce. Then adding a profit amount to it. This method is frowned on as it allows competitors to make your product for less and under sell you at the same time. Price –based costing –allows business owners to begin with what the customers are willing to pay. This way is preferred in the business world as it allows wiggle room for the business owner to bring down or raise the unit price if competition is encountered.
So the Break even point = fixed costs/ unit selling price –variable cost.
Reference:
Break-even Analysis. (n.d.). Retrieved from http://www.sba.gov/content/breakeven-analysis
Noreen, E.W., & Brewer, P.C. & Garrison, R, H. (2014). Managerial Accounting
for Managers. New York, NY: McGraw- Hill Companies.
Richards, D. (2014). How to do a break even analysis. Retrieved September 12,
2014 from http://entrepreneurs.about.com/od/businessplan/a/breakeven.htm
Discussion #2 : Cost-Volume-Profit Analysis
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One important job feature of a manager is to understand cost behavior and the kind of effect it will have on a company’s profit margin. Managers have to consider changes in price (selling and buying), cost, and volume; each of these attributes are important and cannot be overlooked when working on a budget for a company. The analysis of cost, volume, and profit helps a company to understand their break-even point and what they can work on to ensure a profit. A break-even point is the level of sales where a company will not sustain a loss, yet not make a return (Freedman, 2014). Also, as we discussed last week, there are different types of costs and in terms of contribution margin and net operating income, the variable costs (costs that evolve based on changes in an activity, they respond in direct reaction and equitably to changes in activity level or capacity) that a company will incur are different from their fixed costs (costs that do not vary with variations in production level or sales volume). Examples of fixed costs can include rent, insurance, loan payments, advertising, and equipment leases while variable costs can include the cost of raw materials, sales commission, hourly production wages, packaging supplies, and shipping costs (Inc., n.d.).
The contribution margin (CM) of a business is the amount left over from their sales revenue after variable expenses have been removed. Another way to look at the contribution margin is to utilize this equation:
Operating Income = Sales - Total Variable Costs - Total Fixed Costs
The equation above can be further broken down into this:
Operating Income = (Price X #Units Sold) - (Variable Cost Per Unit X Number of Units Sold) - Total Fixed Costs
It is basically known as the cost volume profit equation (Peavler, n.d.). By knowing and understanding how this equation works as well as their break-even point, businesses are better informed in making decisions that can help their business grow such as expanding the business or curtailing costs in areas that will not be detrimental to the business. Also, the contribution margin analysis is a useful tool for managers to allocate their spending wisely and to help the company visualize profit after the break-even point. In addition, it is a great tool for individuals seeking to purchase a business; they can see the breakdown of each dollar being spent and received by the business.
References
Freedman, J. (2014). Cost-Volume-Profit Relationship & Break Even Analysis. Retrieved September 12, 2014, from http://smallbusiness.chron.com/costvolumeprofit-relationship-break-even-analysis-67266.html
Inc. (n.d.). Fixed and Variable Expenses. Retrieved September 12, 2014, from http://www.inc.com/encyclopedia/fixed-and-variable-expenses.html
Peavler, R. (n.d.). 3 Factors That Affect Your Company's Profit. Retrieved September 12, 2014, from http://bizfinance.about.com/od/pricingyourproduct/a/how-to-do-cost-volume-profit-analysis.htm
Discussion #3: Cost Volume Profit Analysis (CVP)
Cost Volume Profit (CVP) analysis is used to analyze the relationships between changes in activity and changes in total sales revenue, costs and profit. It can be particularly useful for businesses that are starting up operations or going through tough economic condition. CVP can serve as a critical tool in the management process as it is used to make important planning decisions concerning appropriate levels of production and spending (David, 2003). CVP analysis helps by examining the number of units of a product that must be sold in order for that business to break even which means that both fixed and variable costs are covered by the sales revenue thus allowing the business to determine what the effect of various changes in operating costs or the selling price of a product is on the profits as in how the profitability is affected if the selling price of the product is reduced or the fixed cost is increased. It also helps with examining the volume of sales that is required to attain a specific level of profit and to establish the amount by which the current sales level can decrease before losses are incurred (Susan, 2011).
CVP analysis actually makes certain assumptions about the business environment within which it is operating. It assumes that all the variables remain constant except volume which means that volume is the only factor that can cause cost and profits to change. It assumes that only one product is under examination or in case of a number of products, they are being sold in the same proportions. CVP suggests that the variable cost per unit and the selling price per unit do not change for example in case of discounts the variable cost remains the same. In CVP, profits are calculated using variable costing as variable costing facilitates profit analysis by separating variable and fixed costs and treats fixed costs as a period expense rather than attempting to allocate them to products (Susan, 2011). CVP analysis examines the relationship between volume of sales, costs and profit during a period of a year and it is suggested that it would not be easy to change selling prices, variable and fixed costs during this time.
An important concept related to CVP analysis is contribution margin which is used as an intermediate calculation, however, this metric can provide information by itself (John, 2010). The contribution margin ratio, contribution margin divided by sales, helps management in finding out the amount out of each dollar that is going to go towards covering fixed expense up until they reach the break-even. The contribution margin ratio helps managers in understanding the amount out of each dollar that goes towards the company's profit after the break-even point has been reached.
Reference
Susan E. Wyse (September, 2011). Study on Job Order Costing and Process Costing. Retrieved from http://www.ukessays.com/essays/accounting/study-on-job-order-costing-and process-costing-accounting-essay.php
David Madison (2003). Analyzing Cost Volume Profit Relationships. Retrieved from http://www.swlearning.com/ibc/albrecht9e/pdf/67604_c02_42-113.pdf
John Freedman (2010). Cost-Volume-Profit Relationship & Break Even Analysis. Retrieved from http://smallbusiness.chron.com/costvolumeprofit-relationship-break-even-analysis-67266.html
Discussion #4
For this week’s topic, I have selected the concept of break even analysis. This is the idea that there is a balance when a company is not making money but it is not losing it either (Noreen, Brewer & Garrison, 2014). Break even analysis takes advantage of times in a business when keeping the doors open and maintaining operations is the goal. In such times, there is not the focus on acquiring profit or loss. One example when a business would do this would be when it’s being threatened to go out of business altogether. Also, it’s a way a business can forecast when it expects to start making a profit (United States Small Business Administration, 2014).
To conduct a break even analysis, the fixed and variable costs must both be examined (Peavler, 2014). Break even analysis means the business has a target profit of zero. During the planning stages of a company’s business plan, most companies will look at their break even point. This is done in order to find the bare minimum that they will need to sell in order to avoid incurring a loss or a profit as a bare minimum target goal. This analysis will include looking at the number of units that will need to be sold in order to cover fixed costs for the company. Fixed costs include items such as electric bill, payroll and office space rent.
Let’s consider the example of a new start up bakery. The first year, I would plan out my fixed costs and my projected sales volume to determine the minimum number of cupcakes I would have to sell to remain operational and in business. As long as the bakery is achieving at least these bare minimum sales of cupcakes, I would remain open. Ultimately, the goal is to turn a profit but for the first few months, I might be willing to simply break even and remain in business as long as eventually I would go into profit. So, perhaps I need to sell 300 cupcakes a month. For this, I might want to further analyze my fixed costs the amount of ingredients for the cupcakes. How much flour, sugar, butter and etc goes into each cupcake thus giving me the cost for each cupcake. As well, I could even further break it down – for the sake of argument – into how much it costs to bake each cupcake based on having the oven on.
References
Noreen, E. W, Brewer, P., & Garrison, R. (2014). Managerial Accounting for Managers (3rd
Ed.). New York, NY: McGraw-Hill Irwin.
Peavler, R. (2014). How to calculate breakeven point. Business Finance. Retrieved from:
http://bizfinance.about.com/od/pricingyourproduct/a/Breakeven_Point.htm
United States Small Business Administration. (2014). Breakeven analysis. Finance Your
Business. Retrieved from: http://www.sba.gov/content/breakeven-analysis
Discussion #5
In a business a manager needs to make decisions and can use a tool at their disposal called the Cost - Volume - Profit analysis (CVP). The Cost – Volume – Profit analysis is a way for managers to make a decision by predicting a course of action. The decisions of managers are broken down into probabilities to help the manager make / predict the next step (Lewis, 2014).
“CVP analysis has following assumptions (Jan, 2013):
1. All cost can be categorized as variable or fixed.
2. Sales price per unit, variable cost per unit and total fixed cost are constant.
3. All units produced are sold.
Where the problem involves mixed costs, they must be split into their fixed and variable component by High-Low Method, Scatter Plot Method or Regression Method (Jan, 2013).”
The questions that a Cost – Volume – Profit analysis can help predict is what the companies breakeven point is, to assist in knowing how future spending and production will be if the business succeeds or fails. Once a manager knows what their breakeven point is then they can decide on spending and production in order to increase profitability. Cost – Volume – Profit analysis are statistical models that can be broken down into probabilities to help a manager with the decision process (Lewis, 2014).
Cost – Volume – Profit analysis most important function is the breakeven point. To calculate the breakeven point will be in dollars by multiplying the sales price for the product by the breakeven point in units. The word breakeven means not a win (positive) or loss (negative) it “breaks even”. The best way to break even would be to equal zero. The units a business has to produce and sell to make a profit of zero is when the business breaks even i.e. the breakeven point. When a business has a breakeven point of zero means the total revenue is equal to total expenses. So how does a business know if they are making a profit or a loss with the breakeven point? The answer would be to see what the operating income equals too; if it equals zero then the breakeven point has been reached. However, in order to know if a profit or loss is present is to see if the operating income is positive or negative. A positive result means the business is making a profit where if a negative result means the business is making a loss (Peavler, 2014).
References
Jan, I. (2013). CVP Analysis. Accounting Explained. Retrieved from http://accountingexplained.com/managerial/cvp-analysis/
Lewis, J. (2014). Advantages & Disadvantages of Cost-Volume-Profit Analysis. Houston Chronicle. Retrieved from http://smallbusiness.chron.com/advantages-disadvantages-costvolumeprofit-analysis-35135.html
Peavler, R. (2014). How to do Cost-Volume-Profit Analysis – An Introduction. About money. Retrieved from http://bizfinance.about.com/od/pricingyourproduct/a/how-to-do-cost-volume-profit-analysis.htm
Discussion #6: Contribution Margin
Managers must understand how much the organization earns from certain products and services and thus they look at a calculation known as contribution margin. By definition the contribution margin (CM) is the profit earn from products or services when all applicable variable costs are subtracted from the actual sale price of the item. The formula to determine CM is Product Sales Price (revenue) – Variable Costs of the product. Calculation of the CM will not show what the company has netted from the sale, but will show how much of the sale is left to pay any fixed costs, thus showing what profit is earned (Horngren, et al., 2007). CM looks specifically at the variable costs of production, those costs which change according to volume such as direct materials, and help to show how changes in sales volumes will impact the profits generated from products. This information is vital because managers can use such information to choose which products generate the most profits and what levels of sales will be necessary to make a product viable. In addition, CM can be used to understand pricing for products because CM is used to understand the prime price point that will assure a profit and what price points may be too low or even too high. If the price is too low the company may lose money, yet if the price is too high the sales volumes may drop to a point which means that the product is not generating sufficient revenues to cover all costs (Jackson, Sawyers, & Jenkins, 2009).
CM looks at the behaviors of the organization and when calculated helps managers to look at how the net income is impacted by certain products. The information is particularly useful when trying to choose when to end a product sales run when the sales no longer justify the costs of production. Also, companies can see when the changes in costs force the company to raise the price of the good in the market (Hansen, Mowen, & Guan, 2009). When companies address product price changes, they generally refer to the change in costs associated with products. Looking at chocolate for example, when the price of cream, sugar, or cocoa changes it impacts the variable costs of goods. While the fixed costs will not change, the profit per-item will be impacted. When the company sees that variable costs are impacting profitability, they must either discontinue the product or raise the price if the market will bear the higher price (Hansen, Mowen, & Guan, 2009).
References
Hansen, D., Mowen, M., & Guan, L. (2009). Cost Management: Accounting and Control (6e). Mason, OH: South-Western.
Horngren, C., Sundem, G., Stratton, W., Schatzberg, J., & Burgstahler, D. (2007). Introduction to Management Accounting, 14th ed. Upper Saddle River, NJ: Prentice Hall.
Jackson, S., Sawyers, R., & Jenkins, G. (2009). Managerial Accounting: A Focus on Ethical Decision Making (5e). Mason, OH: South-Western.
Discussion #7: Week 2 -- Cost-Volume Profit Analysis
When people see a business operating by serving people, producing and/or selling products to be purchased by customers, from the outside looking it, profits might seem like the only thing to be concerned about, but interestingly enough, the profits that a business makes does not only deal with the concepts of buying and selling. There are five factors that affect the profits that a business will make. They are selling price, sales volume, unit variable costs, total fixed costs, and mix of products sold. These five factors are taken into consideration when it comes to cost-volume profit analysis, which is an important and powerful tool used by manager to gain an understanding of the relationship between cost, volume and profit (Noreen , Garrison, & Brewer, 2014). In order for this tool to be useful assumptions have to be made, for example, that the sales price, fixed costs and variable cost per unit are constant. A number of equations use price, cost, and other variables to perform analysis for cost accounting to determine the breakeven point of cost and volume of goods (Investopedia, n.d.).
Cost-volume profit analysis is helpful to managers because the information it provides is objective and allows managers to assess, calculate and forecast business performance. This allows managers to make better business decisions that will affect the success of the company. Cost-volume profit analysis also provides managers with the ability to answer the question, what is the breakeven point? Knowing the breakeven point is will allow managers to know how the company needs to perform to keep from failing and how much of a profit the company will make depending on well the company does in sales. Now with this information a manager can decide to make changes in spending that will put the company in position to increase its profit margin. Managers can also use the analysis to figure out the probability of success with different decisions, which can further assist managers to choose the best decision for the company.
Cost-volume profit analysis has an advantage and disadvantage to it. As an advantage managers can use this cost accounting tool to see a “detailed snapshot of company activity. This includes everything from the cost needed to produce a product to the amount of the product produced” (Lewis, n.d.). Because of the variable cost to do business managers can input different spending figures for a number of scenarios to get an idea of how the business would perform in a number of possibilities. Yet a disadvantage is that because the cost-value profit analysis deals with projections, which have to do with estimates and not precise numbers, the analysis can ultimately lead to inaccurate projections (Lewis, n.d.).
References:
Cost-Volume Profit Analysis. (n.d.). Investopedia. Retrieved from the World Wide Web on September 10, 2014 from: http://www.investopedia.com/terms/c/cost-volume-profit-analysis.asp
Lewis, J. (n.d.). Advantages & Disadvantages of Cost-Volume-Profit Analysis. Chron. Retrieved from the World Wide Web on September 10, 2014 from: http://smallbusiness.chron.com/advantages-disadvantages-costvolumeprofit-analysis-35135.html
Noreen, E. W., Brewer, P. C., & Garrison, R. H. (2014). Managerial Accounting for Managers. New York, NY: McGraw-Hill/Irwin.
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