Managerial accounting and introduction to concepts methods and user 11e by maher chapter 06

FINANCIAL MODEL Financial modeling enables analysts to test the interaction of economic variables in a variety of settings.. Financial modeling enables analysts to test the interaction o

Financial Modeling

for Short-Term Decision-Making

Florida Institute of Technology

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FINANCIAL MODEL

Financial modeling enables analysts to test the interaction

of economic variables in a variety of settings It

requires analysts to develop a set of equations that

represents a company’s operating and financial

relations

Financial modeling enables analysts to test the interaction

of economic variables in a variety of settings It

requires analysts to develop a set of equations that

represents a company’s operating and financial

relations

LO 1

COST-VOLUME-PROFIT (CVP)

CVP can be used to answer questions such as

 What effect on profit can GM expect if it builds a

larger SUV?

 How will NBC’s profit change if ratings increase

for its evening news program?

 How many subscribers must a Dish Network

obtain to break even for the year?

 What happens if Verizon reduces fees charged to

LO 2

EXAMPLE: Early Horizons Daycare

Early Horizons Daycare is a daycare center that defines a

unit of output as “service provided for 1 child for a

month.” Building capacity is 30 children An accountant

developed the following estimates:

LO 2

Continued

Variable cost per child per month 200

E

H

D

CAPACITY and COSTS

Early Horizons Daycare has a capacity of 20 units ( relevant range ), after which it must hire more staff.

Variable costs include

Snacks and food

 Supplies

A portion of insurance

Fixed costs include:

Rent and utilities

LO 2

E

H

D

Is the point in the basic CVP model where revenues equal

costs.

Total Revenue = Total Costs

LO 2

BREAK-EVEN: Table Format

Using break-even computations:

Can we use

contribution margin

to compute break- even (BE) volume?

= Sales revenue - Costs

= Sales revenue -Variable costs (VC) – Fixed costs (FC)

= ( Unit s elling price (SP) × Sales volume)

- (VC per unit × Sales volume) - FC

( $600 - $200 ) × Sales volume = $5,000

LO 2

By graphing revenues and costs on same graph, you can

find BE,

profit and loss areas

By graphing revenues and costs on same graph, you can find BE,

LO 2

EXHIBIT 6.2

Slope of line is

variable cost per unit

Slope of line is

variable cost per unit

Break-even Volume = Fixed Costs / CM

E

H

D

TARGET PROFIT: CM Approach

TARGET PROFIT: Reminder

MARGIN OF SAFETY: Definition

Is the excess of projected (or actual) sales units over Break-

even unit sales level.

Sales units – BE Sales units or

Sales dollars – BE Sales dollars

LO 3

Refers to the proportion of fixed and

variable costs to total costs.

Is the extent to which an organization’s

Note: the higher the fixed costs, the higher the

break-even point.

CM / Sales

LO 4

LO 6

MANAGERS WANT TO KNOW!

How can a company determine the effect of

taxes will be on its

profits?

After tax profits =

Before tax profits X (1 - tax rate)

E

H

D

SUMMARY OF SIMPLIFYING CVP

ASSUMPTIONS

 Can separate total costs into fixed and variable

 Cost and revenue behavior is linear Implies the following in

the relevant range

 Total fixed costs do not change

 Variable costs per unit remain constant

 Selling price per unit remains constant

 Product mix remains constant over relevant range

LO 7

USING ABC FOR EHD

Previously, Early Horizons Daycare used

a financial model with only volume (number of children) as the cost driver

What if multiple cost drivers using the cost hierarchy are identified and used?

a financial model with only volume (number of children) as the cost driver

What if multiple cost drivers using the cost hierarchy are identified and used?

LO 8

E

H

D

Activity Category Example

Capacity Size limitations Building size: 30 children

Customer Needs Children transported

Product Production needs Field trips

LO 8

(Unit-level cost × #children) +

(Batch-level cost × # rooms) +

(Product-level cost × #field trips) +

(Customer-level cost × #children transported) +

(Capacity-level costs × #facilities)

Continued

EHD: ABC and Sensitivity Analysis

EHD: ABC and Sensitivity Analysis

End of CHAPTER 6