The Cost/Volume Relationship |
Usually the greater the volume produced the lower the cost of the item. Why? A Product cost can be broken into fixed and variable costs |
| Fixed Costs | Variable Costs |
| Those that have to be incurred to do business - not related to volume | Those costs that are incurred to produce the product - directly relates to volume |
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Units |
1,000 |
5,000 |
10,000 |
Fixed Cost |
$100,000 |
$100,000 |
$100,000 |
Variable Cost -$50 each unit |
50,000 |
250,000 |
500,000 |
Unit Cost |
$150 |
$70 |
$60 |
Want to know how much
production volume is needed to breakeven? Want to know how much production volume is needed to breakeven? Breakeven = Where sales volume is such that there is no Profit or Loss |
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Or Total Revenue = Total Cost |
Want to know how many units have to be sold to make a specified amount? Total Revenue = Total Cost + Profit
For example Selling Price (S.P) = $150/unit Fixed Cost (F.C) = $ 1,00,000 UC/unit = $50
To make $75,000
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| These calculations are done when planning/deciding whether
to produce a product or build a plant. (i.e.
whether necessary market exists at the price charged.) See what the effect of price changes have on
In many cases this analysis leads to redesign to lower
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| A very practical concept is the Contribution
Profit Concept
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Can see since fixed costs don't change the higher the contribution profit the higher the profit. This means that any activity not making a contribution profit should be investigated and/or possibly replaced in order to utilize the fixed cost better. Required Sales Revenue
Conservative is to design plant not to have a high fixed cost and low variable cost because changes in sales revenues everely affect their profitability
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