Linda Fearn asks your help in constructing a Cost-Volume-Profit graph. Explain to Linda (a) how the break-even point is plotted, and (b) how the level of activity and dollar sales at the break-even point are determined.
(a) To plot the break-even point on a Cost-Volume-Profit (CVP) graph, follow these steps:
1. Determine the fixed costs: Fixed costs are expenses that do not change with the level of activity. These can include rent, salaries, insurance, etc.
2. Calculate the contribution margin per unit: The contribution margin is the difference between the selling price per unit and the variable cost per unit. It represents the amount that contributes to covering the fixed costs after variable costs have been deducted.
3. Determine the break-even point in units: The break-even point is the level of activity at which total revenue equals total costs (fixed and variable). Divide the fixed costs by the contribution margin per unit to calculate the break-even point in units.
4. Plot the break-even point on the graph: On the CVP graph, denote the break-even point by drawing a point where the total cost and total revenue lines intersect.
(b) To determine the level of activity and dollar sales at the break-even point, use the following calculations:
1. Level of activity at the break-even point: This is the number of units that need to be sold to cover all costs. It is already calculated in step 3 above.
2. Dollar sales at the break-even point: Multiply the level of activity at the break-even point by the selling price per unit. This will give you the total revenue required to cover all costs at the break-even point.
By following these steps, you can plot the break-even point and calculate the level of activity and dollar sales at that point on a Cost-Volume-Profit graph.