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I'm Larry Walther, and
this is principlesofaccounting.com chapter 18.
In the previous module, we considered CVP or
cost volume profit analysis for a single product.
Oftentimes however, a business will deliver multiple products,
each involving a unique contribution margin and contribution margin ratio.
And so in this module, we are going to consider CVP analysis for
firms that have multiple products.
Recognize that businesses may offer a diverse set of products,
each having a unique selling price and each having a unique contribution margin.
And we're going to use for example Hummingbird Feeders.
Hummingbird Feeders sells feeders and nectar packets.
Now the feeders sell for $15 per unit and have a variable cost of production of $10,
so they have a $5 contribution margin per unit.
And the nectar packets sell for $3 and have a $1 cost of production and
so their contribution margin is $2 per unit.
If fixed cost for Hummingbird Feeders is $100,000,
the question is, what is the break even point?
To determine the break even point, we need to determine the product mix, that is,
how many feeders do we sell relative to the nectar packets?
And some analysis has been done to determine that for
every feeder sold, there are ten nectar packets sold.
And so, we'll define a unit as ten nectar packets and one feeder.
When we sell a unit, we find that the contribution margin for
that unit is $5.00 for the feeder and $20.00 for the nectar packets,
that is $2.00 times ten nectar packets.
So the unit contribution margin is $25,
and we would need to sell 4,000 units to break even.
That is $100,000 of fixed cost divided by the $25 unitized contribution margin.
This would translate into sales of $180,000.
That is 4,000 feeders selling at $15 a piece,
plus 40,000 nectar packets selling at $3 a piece.
This assumes the given product mixed ratio holds true
if the 180,000 of sales all came from feeders and no packets of nectar, for
example, break even would not be reached.
Alternatively, we might reach break-even sooner if we sell a higher
proportion of the higher margin nectar packets.
An alternative way to calculate break-even sales is to divide the fixed
cost by the weighted average weighted contribution margin ratio.
In this case, the fixed cost of $100,000 divided by the .555 weighted-average
contribution margin ratio, and I'll show you how to calculate that in a moment,
that amount gives us the break-even sales of $180,000.
So this is a shortcut way to calculate your break-even sales.
But we need to look at this next table to see how we're going to do that.
Remember that the feeders sold for $15, and the nectar packets sold for $3.
And so in unit sales, $15 for a feeder and
10 nectar packets at $30, a unit sales is $45 in total okay?
And 15 of the 45 or one-third of that total relates to the feeder and
two-thirds or 30 divided by 45 relates to the nectar packets.
So those are the product sales to total sales ratios,
as shown in the first column.
We then multiply those amounts times the product contribution margin ratio.
The product contribution margin for the feeders was $5 divided by $15.
And the product contribution for the nectar packets was much higher,
$2 divided by $3.
When we multiply the product contribution margin ratios
times the proportion of sales contributed by each product.
One third for feeders and two thirds of total sales dollars for nectar packets.
We'll get a weighted average ratio on the final column, 0.111 plus 0.444
gives us the weighted average contribution margin of 0.555.
Which again,
we divide into the fixed cost to find the break-even point in sales dollars.
In closing this module, I would want you to consider one additional topic, and that
is, how selling expenses can influence contribution margins or profitability.
Let's consider a company that sells two products and
the sales force earns 5% of sales.
Product A has a $120 sales price and product B has a $100 sales price.
Also, notice that I show the variable production cost.
Product A costs $100 a unit to produce, product B costs $70 per unit to produce.
So the contribution margin on product A is $20, and
the contribution marginal product B is $30.
If you were a salesperson, which would you rather sell?
You would rather sell product A, because 5% of 120 is more than 5% of 100.
So the sales person might have incentive to deliver or
try to cause a customer to buy product A in lieu of product B.
This is not congruent with the interest of the entity,
necessarily, because the contribution margin for
the business is much higher on product B than it is on product A.
And so what this calculation show is how one is very careful in terms of providing
incentive compensations so that they align with the interest of the organization.
It probably does not make sense for the sales people to be
essentially encouraged to sell a product that has a lower contribution margin.
The managerial accountant's role in this is to carefully evaluate the business and
make recommendations relative to the strategy for running the business.
This is one of the valuable points of doing cost volume profit
analysis within an organization.
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