Accounting Business Reporting for Decision Making

428 Accounting: Business Reporting for Decision Making

(continued)

profit or the desired profit. In the previous example, ATC needed to have 30 players to break even for

the tournament. The statement of profit or loss at the break-even level of players and players to achieve

a profit of $600 (40 players) is shown in figure 10.7.

Advantage Tennis Coaching

Statement of profit or loss at the break-even level of sales (players)

30 players 40 players

Sales ($150)

Less: Variable costs ($90)

$ 4 500

2 700

$ 6 000

3 600

Contribution margin

Less: Fixed costs

1 800

1 800

2 400

1 800

Profit $ 0 $ 600

FIGURE 10.7 Statement of profit or loss at the break-even level of sales

CVP can be used in an equation form or as a ratio. In some circumstances, the unit data may not be

available, or the aim may be to calculate the break-even in total sales dollars. In such circumstances,

the contribution margin ratio can be used. This issue is explored later in this chapter.

The break-even calculation can be viewed as an equation in the following form.

s(x) = vc(x) + fc for break-even and

s(x) = vc(x) + fc + p for meeting a desired profit

where:

s = selling price per unit

x = number of units

vc = variable cost per unit

fc = fixed costs

p = desired profit

We have explored only the very basics of CVP analysis here. Each entity would need to find its own

application of the concepts outlined. CVP analysis provides the opportunity for spreadsheet analysis,

including ‘what if’ and sensitivity analysis. Indeed, some entities use quite complex modelling to

identify break-even points. Moreover, some entities adapt the basics outlined here to suit their own

environment. For example, transport entities speak of break-even kilometres or miles, hotels speak of

break-even occupancy rates, and airlines speak of break-even passenger miles or kilometres. While each

of these calculations will be made at a more complex level, they still require an understanding of the

fundamentals outlined here.

Another measure that can be used to assess risk associated with sales is the margin of safety. The

margin of safety is commonly regarded as the excess of revenue (or units of sales) above the break-even

point. It provides an indication of how much revenue (sales in units) can decrease before reaching the

break-even point, and may be calculated as:

Margin of safety

in units

=Actual or estimated units

of activity

• Units at break-even
  point
  Margin of safety
  in revenues

=Actual or estimated

revenues

• Revenues at break-even
  point

If the margin of safety is small, managers may put more emphasis on reducing costs and increasing

sales to avoid potential loss. A larger margin of safety gives managers more confidence in making plans

such as incurring additional fixed costs.