Decision Points

Decision	Guidelines
How can CVP analysis help managers?	CVP analysis assists managers in understanding the behavior of a product’s or service’s total costs, total revenues, and operating income as changes occur in the output level, selling price, variable costs, or fixed costs.
How can managers determine the breakeven point or the output needed to achieve a target operating income?	The breakeven point is the quantity of output at which total revenues equal total costs. The three methods for computing the breakeven point and the quantity of output to achieve target operating income are the equation method, the contribution margin method, and the graph method. Each method is merely a restatement of the others. Managers often select the method they find easiest to use in a specific decision situation.
How can managers incorporate income taxes into CVP analysis?	Income taxes can be incorporated into CVP analysis by using the target net income to calculate the target operating income. The breakeven point is unaffected by income taxes because no income taxes are paid when operating income equals zero.
How do managers use CVP analysis to make decisions?	Managers compare how revenues, costs, and contribution margins change across various alternatives. They then choose the alternative that maximizes operating income.
What can managers do to cope with uncertainty or changes in underlying assumptions?	Sensitivity analysis is a “what if” technique that examines how an outcome will change if the original predicted data are not achieved or if an underlying assumption changes. When making decisions, managers use CVP analysis to compare contribution margins and fixed costs under different assumptions. Managers also calculate the margin of safety equal to budgeted revenues minus breakeven revenues.
How should managers choose among different variable-cost/fixed-cost structures?	Choosing the variable-cost/fixed-cost structure is a strategic decision for companies. CVP analysis helps managers compare the risk of losses when revenues are low and the upside profits when revenues are high for different proportions of variable and fixed costs in a company’s cost structure.
How can managers apply CVP analysis to a company producing multiple products?	Managers apply CVP analysis in a multiple product company by assuming the sales mix of products sold remains constant as the total quantity of units sold changes.
How do managers apply CVP analysis in service and not-for-profit organizations?	Managers define output measures such as passenger-miles in the case of airlines or patient-days in the context of hospitals and identify costs that are fixed and those that vary with these measures of output.
What is the difference between contribution margin and gross margin?	Contribution margin is revenues minus all variable costs, whereas gross margin is revenues minus cost of goods sold. Contribution margin measures the risk of a loss, whereas gross margin measures the competitiveness of a product.