Profitability Index Rule

And finance Allah shmoop What is CVP and or cost

volume Profit analysis All right For starters CVP is not

that thing that runs a computer That cpu Yeah And

it's not a drugstore that c v s And it's

not a fancy name for resumes That's uh just CV

CVP cost volume profit analysis Well CVP is all about

profits rather than optimizing profits Yes subtle thing There you

are running a company You make foam padding for people

who experienced a psychotic breaks to put on their bedroom

walls You're trying to figure out what pricing delivers the

best operating or net income returns All right what time

is it Yes it's time for CVP analysis Yet you

knew going well this thing helps you find the answer

in a kind of matthew way to optimizing your problems

You know So you're not just throwing darts or shaking

a magic eight ball or something although we think that's

pretty cool OK well when you run a CVP you

make some assumptions You use a whole lot of scenarios

that don't necessarily reflect real life but they help the

math along For instance you assume all of your inventory

gets sold like you're not monkeying around with inventory ballooning

on your shelves and hiding profits Nor are you depleting

it suddenly to generate suddenly a lot of cash and

well taxes Maybe you're also assuming that pricing is flat

You're neither raising nor lowering pricing and your margins then

should pretty much stay about the same You know like

if you're keeping prices flat the price per square yard

stay steady for the head butter two thousand And that

thing which is your primary product right You're also assuming

that your cost of producing the foam is flat and

squishy Well the variable costs remain constant flat you know

like the padding And you're assuming that there are no

meaningful changes to your phone fixed costs like rent or

insurance or the machine that squeezes out the patting twenty

four by seven The on ly change here the on

ly input in the equation you're going to monkey with

is act activity I e volumes sold So the basic

question you're asking How does prophet change when we change

the amount of stuff we make What happens if we

make Maur What happens if we make less That's what

we're asking Well the star of the show and CVP

analysis is country abuse Shin margin So you're producing million

yards of patting CVP is all about figuring out what

happens when you produce that million and one thir million

and first yard of padding When you produce your first

yard will that yard costs a fortune right from a

mass standpoint you bought all that equipment hired all those

workers built a whole factory just to make one yard

of patting very expensive But as you make more well

the cost gets spread out over more product All the

fixed costs like rent insurance and so on get applied

to a larger number of units There Amor ties across

a bigger base right the per unit cost then drops

well Once you're running the factory and churning out patting

it becomes all about contribution margin like that's the rule

that runs your company Optimize it So if that last

pad sells for ten bucks a yard and it cost

you six bucks a yard to make well then your

contribution per yard is four bucks and your contribution margin

is forty percent Yeah that works for over ten It's

basically revenue or rather sales than subtracting all the variable

costs in making that yard That's on a per unit

basis If the whole company's sold twenty million dollarsworth of

lunatic padding in a given year and it had total

variable cost If I'LL say fourteen million well then companywide

contribution margin delivery would be about six million bucks right

Twenty minutes fourteen contribution think donation to profits from sales

or something like that So the next big thing think

about is the break even point At what volume or

level of sales does the head butter two thousand cover

It's fixed Recurring costs where profits are zero and the

company is joss squeaking by like How much should it

produce Well let's say your factory has six million dollars

in fixed costs That amount covers things like rent on

the factory in the cost of the machines and so

on When you make that first yard of patting it

cost six million dollars sell it for ten bucks and

you've lost five million nine hundred ninety nine thousand nine

hundred ninety dollars Good for you Okay so we need

to figure out just how many yards you have to

make until that bottom line reaches zero Well At what

point Teo sales cover costs wealth the math equation sales

At this point this break even point equals total variable

cost plus total fixed costs and fixed costs are the

same as the contribution totals So the Head Butter two

thousand has fourteen million dollars invariable costs The cost of

the raw materials and labor IT center all included in

there and there are six million dollars in fix recurring

cost So then it's sales of twenty million box It's

just breaking even That sales volume equates to two million

yards worth of padding Sold it ten bucks each with

two million yards you're covering for the cost of the

patting itself and the labor and the electricity and the

raw materials and the facility caused and sales and marketing

and all of it together is fourteen million dollars invariable

costs Well you're also covered for the six million bucks

worth of fixed recurring cost like rent insurance and loading

dock snacks and so on And note that some cost

like manufacturing or sales can be both fixed and variable

right You're storing tons of patting You need rent more

storage space so your rent goes up So when you

put together a mini income statement like this you label

it contribution margin income statement because it's not a gap

compliance set of numbers There's no set of laws that

makes you Adam up in a certain way right They're

just there to help managers you know manage okay back

to break even The fancy formula runs like this Break

even Sales is or equals total fixed costs over contribution

margin ratio Well in your case you have six million

dollars in fixed costs and a contribution margin of seven

twenty It's or thirty five percent So you divide the

six million by the point three five to get twenty

mill in sales as break even see it's like magic

Well given the cost structure to break even I'ii stop

losing money on the whole deal You need to reach

twenty million in sales After that you've taken care of

all the fixed costs the rent the equipment and so

on more than twenty million in sales and you start

to book profits Yeah which should keep your shareholders from

hitting their heads against the wall though if they did 00:06:05.295 --> [endTime] Well at least you'd have some new customers