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

CHAPTER 6
Financial Modeling
for Short-Term
Decision-Making

PowerPoint Presentation by
LuAnn Bean
Professor of Accounting
Florida Institute of Technology
© 2012 Cengage Learning. All Rights Reserved. May
not be copied, scanned, or duplicated, in whole or in
part, except for use as permitted in a license
distributed with a certain product or service or
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classroom use.

Managerial Accounting 11E
Maher/Stickney/Weil

1


☼

CHAPTER GOAL

☼

This chapter explains and illustrates financial modeling. Financial
modeling can

Provide an overview of an organization’s financial
activities
Help managers make specific decisions
Financial modeling relies on concepts of fixed and variable cost
behavior.

2


LO 1

FINANCIAL MODEL
Financial
Financial modeling
modeling enables
enables analysts
analysts to
to test
test the
the interaction
interaction
of
of economic
economic variables
variables in
in aa variety
variety of
of settings.
settings. ItIt
requires

requires analysts
analysts to
to develop
develop aa set
set of
of equations
equations that
that
represents
represents aa company’s
company’s operating
operating and
and financial
financial
relations.
relations.

3


LO 2

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
customers?
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E
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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:
Price per child per month

$ 600

Variable cost per child per month

200
5,000

Fixed costs per month
Continued

5

E
H
D

LO 2

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
A portion of insurance
Minimum staffing
6


LO 2

BREAK-EVEN
BREAK-EVEN POINT:
POINT: Definition
Definition

Is the point in the basic CVP
model where revenues equal
costs.
Total Revenue = Total Costs

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E
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D

LO 2

BREAK-EVEN: Table Format
Using break-even computations:
Sales Revenue (12.5 X $600)

$ 7,500

Less Variable costs (12.5 X $200)

Contribution Margin (CM)
Less Fixed costs
Operating profit

2,500
$ 5,000
5,000
$

0

8


LO 2

CONTRIBUTION
CONTRIBUTION MARGIN:
MARGIN:
Definition
Definition

Is the excess of revenue over
variable costs.
Total Revenue – Variable Costs

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E
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LO 2

MANAGERS WANT TO KNOW!

Can we use

contribution margin
to compute breakeven (BE) volume?
YES!
BE Volume =
Fixed cost / CM per child

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CONTRIBUTION MARGIN
APPROACH

LO 2

Using the contribution margin approach:
Break-even Volume = Fixed Costs / CM per child
= $5,000 / $400
= 12.5 children
Click the button to skip
equation approach

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E
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D

LO 2

EQUATION APPROACH
Using the equation approach (Operating profit at break-even = 0):

Operating profit 0
= Sales revenue - Costs
= Sales revenue -Variable costs (VC) – Fixed costs (FC)
= (Unit selling price (SP) × Sales volume)
- (VC per unit × Sales volume) - FC
($600 - $200) × Sales volume = $5,000
Sales volumeBE = $5,000/$400 = 12.5 children/month
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LO 2

MANAGERS WANT TO KNOW!

Can we graph the
relationships in CVP
analysis?

YES!

13

LO 2

E
H
D

By
By
graphing
graphing
revenues
revenues
and
andcosts
costson
on
same
samegraph,
graph,
you
youcan
can
find
findBE,
BE,
profit
profitand
and
loss
lossareas.

areas.

Break-even Volume = Fixed Costs / CM

EXHIBIT 6.1
14


LO 2

E
H
D

Slope
Slopeof
of
line
lineisis
variable
variable
cost
costper
per
unit.
unit.
Break-even Volume = Fixed Costs / CM

EXHIBIT 6.2
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LO 2

TARGET PROFIT: CM Approach
Sales revenue (20*$600)

$ 12,000

Less Variable costs (20*$200)

4,000

Contribution Margin

$ 8,000

Less Fixed costs

5,000

Operating profit

$ 3,000

Target profit Volume = (Fixed costs + Target Profit) / CM

= ($5,000 + $3,000) / $400
# children = 20
Continued
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E
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D

LO 2

TARGET PROFIT: Equation Approach
Sales revenue (20 X $600)

$ 12,000

Less Variable costs (20 X $200)
Contribution Margin

4,000
$ 8,000

Less Fixed costs

5,000

Operating profit

$ 3,000

Sales revenue – Variable costs - Fixed costs = Operating Profit
($600 - $200) × Sales volume - $5,000 = $3,000
$400*Sales volume = $8,000
Sales volume = 20 children
Continued
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LO 3

TARGET PROFIT: Reminder
Sales revenue (20 X $600)

$ 12,000

Less Variable costs (20 X $200)
Contribution Margin

4,000
$ 8,000

Less Fixed costs

5,000

Operating profit

$ 3,000

Target profit Volume = (Fixed costs + Target Profit) / CM

Continued
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E
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LO 3

EARLY
EARLY HORIZONS
HORIZONS DAYCARE
DAYCARE::
Sensitivity
Sensitivity Analysis
Analysis
Base Cost

EXHIBIT 6.3

Assumptions

FC $500

Alt #1

VC $10
Price $60, Vol. 2
Alt #2
Alt #3

Price/child

$ 600

$ 600

$ 600

$ 660

VC/child

$ 200

$ 200

$ 210

$ 200

Monthly FC

$5,000

$4,500

$5,000

$5,000

20

20

20

18

$ 12,000

$ 12,000

$ 12,000

$ 11,880

4,000

4,000

4,200

3,600

$8,000

$8,000

$7,800

$ 8,280

5,000

4,500

5,000

5,000

$3,000

$3,500

$2,800

$ 3,280

Children enrolled
Model results: IS
Sales revenue
Less VC
Total CM

Less FC
Operating profit

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LO 3

MARGIN
MARGIN OF
OF SAFETY:
SAFETY: Definition
Definition
Is the excess of projected (or
actual) sales units over Breakeven unit sales level.
Sales units – BE Sales units or
Sales dollars – BE Sales dollars
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LO 4

COST
COST STRUCTURE:
STRUCTURE: Definition
Definition
Refers to the proportion of fixed and
variable costs to total costs.

OPERATING

OPERATING LEVERAGE:
LEVERAGE:
Definition
Definition

Is the extent to which an organization’s
cost structure is made up of fixed costs.
Note: the higher the fixed costs, the higher the breakeven point.

21


LO 4

What is the
contribution margin
ratio?
Contribution margin ratio
(CMR) is the contribution
amount per dollar of sales.
CM / Sales

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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)

23


LO 7

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

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E
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LO 8

USING ABC FOR EHD
Previously,
Previously, Early
Early Horizons
Horizons Daycare
Daycare used
used
aa financial
financial model
model with
with only
only volume
volume
(number
(number of
of children)
children) as
as the
the cost
cost driver.
driver.
What
What ifif multiple
multiple cost

cost drivers
drivers using
using the
the
cost
cost hierarchy
hierarchy are
are identified
identified and
and used?
used?

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