# Tag Archives | profit

## Cost Volume Profit Formula

Cost-Volume-Profit (CVP) Model

# Cost Volume Profit Formula: Breakeven Sales Volume

Breakeven Sales Volume = Fixed Costs ÷ (Sales Price – Variable Costs)

6,000 = \$30,000 ÷ (\$7 – \$2)

6,000 = \$30,000 ÷ (\$5)

As you can see, the theater has a contribution margin of \$5. That is, the theater makes five dollars per ticket sold. This contribution margin can be used to pay down the theater’s fixed costs. So we divide \$30,000 of fixed costs by \$5 contribution margin. This shows us that the theater must sell 6,000 tickets per quarter to break even. The cost volume profit equation shows us many important aspects of the business of the theater.

Now let’s say the theater doesn’t want to merely breakeven. They actually want to make a profit in the upcoming quarter. Selling 6,000 tickets allows them to breakeven. But how many do they need to sell in order to make a profit of, let’s say, \$10,000? We can find out by using the CVP model and the CVP formula.

When performing CVP analysis in order to determine the sales volume required for a set target profit, you simply add the target profit to the fixed costs. So we have variable costs of \$2, sales price of \$7, and fixed costs of \$30,000. And now we’re adding target profit of \$10,000. Following is how we set up the CVP formula for a target profit.

## Cost Volume Profit Calculation: Target Sales Volume

Target Sales Volume = (Fixed Costs + Target Profit) ÷ (Sales Price – Variable Costs)

Target Sales Volume = (Fixed Costs + Target Profit) ÷ (Contribution Margin)

8,000 = (\$30,000 + \$10,000) ÷ (\$7 – \$2)

8,000 = (\$40,000) ÷ (\$5)

As you see here, the theater must sell 8,000 tickets in order to cover its fixed costs and make a profit of \$10,000 in the upcoming quarter.

Of course, for illustrative purposes, this is a very simple example. Real-world examples may be more complex and have more variables. But this is a basic version of the cost-volume-profit financial model.

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# Backwardation Definition

Backwardation is a term used to describe a commodities market when the spot rates are higher than the future price of that certain commodity. In other words there is a downward sloping forward curve relative to the spot rate set for maturity of the commodity. This is the opposite of a market that is in Contango.

## Backwardation Explained

Backwardation has been seen in commodities like corn, wheat, or oil. A backwardation market usually occurs because farmers and other commodity producers would like to lock in a price so that they do not have to accept the risk of the fluctuations in the market. Many of these farmers will accept a current rate to mark a guaranteed price. The investors on the other hand will need to expect that the spot rate is actually higher so that they can lock in the current future price and make a profit.

### Backwardation Example

Hal, a corn farmer in Nebraska, has been observing prices as of late to decide what he should do about his crop that is about to mature. Hal calculates that the future price of corn is around \$6 per bushel. The spot rate at maturity is \$8. However, Hal knows that this is never for sure. The market has been known to fluctuate the same amount the other way to \$4 per bushel. Hal talks to some of his customers and locks in the future price of \$6 to be sold when the crop matures. Because the customers believe the future spot rate to be correct they are happy to accept the \$6 price. This way when they go to sell in the market they expect to make a profit of \$2 per bushel.

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Business drivers, defined loosely as the main factors and resources which provide the essential marketing, sales, and operational functions of a business, are of paramount importance. As more of an art than a science, business drivers are analyzed by consultants and owners alike. Though no single formula or theory dictates success in business, many best-practices exist which can lead the founder of a firm on the path of success and profit.

Obviously, the business drivers in healthcare will be fairly different than those in a retail clothing store. A useful tool to measure and manage business drivers is a Flash Report!

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Business drivers, explained as the crucial factors which lead to success in business, are more of an art than science. These factors differ widely depending on the industry, scope, and other market dynamics. The success factors of one business may directly account for the failures of another.

### Examples

For example, if a company provides software development, their success factors will be distinct to the information technologies industry. Success may rely on the ability to stand out among similar firms. Examples of this include solid customer service, quick delivery of projects, and technical support. Marketing, likewise, would use the tools of this industry. These might include the following:

• Direct sales
• Referrals from previous clients
• Search engine optimization
• Attendance to major programming conventions

Conversely, the success of a law firm would leverage completely different factors. Operational matters like customer service, project management and delivery, and others may stay the same though emphasis may be placed on thoroughness rather than speed of delivery. Marketing, however, would be completely different: membership to business networking circles, business radio sponsorships, and most of all referrals probably account for more sales than web marketing can supply.

Due to the fact that business drivers vary immensely, hire a consultant with a specialty in the industry of interest. These experts know the struggles, failure, and success factors far more than a person with experience from an unrelated industry. Networking alone will flush out these experts from the events they regularly attend. If you want to find out how you can become a valuable financial leader, download the 7 Habits of Highly Effective CFOs for free.

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# Arbitrage Definition

Arbitrage is the practice of profiting from the mispricing of an asset that trades in multiple markets. For arbitrage to be possible, an asset must trade in at least two different markets. If the same asset is trading in two different markets with two different prices, there is an arbitrage opportunity. The idea is to buy the asset where it is cheaper, sell it where it is more expensive, and pocket the difference.

## Arbitrage Examples

For example, imagine you can buy an apple at the supermarket for fifty cents and sell it to tourists on the sidewalk for one dollar. This is an arbitrage opportunity. You would buy apples at the supermarket and sell them to the tourists. For each apple, you would profit 50 cents.

Similarly, if one US dollar is worth .5000 British pounds in London, and one US dollar is worth .5001 British pounds in New York, the arbitrageur might want to purchase dollars with pounds in London and then sell the dollars for pounds in New York. Depending on the volume and the transaction costs, this could be a profitable arbitrage opportunity.

## Arbitrage and Market Efficiency

Due to market efficiency, arbitrage opportunities are hard to find. When they do exist, they are typically small and fleeting. Profiting significantly from arbitrage often requires timely action and large sums of money. And because of market efficiency, the very act of engaging in arbitrage serves to eliminate the arbitrage opportunity.

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## Activity Based Cost Allocation

Implementing Activity Based Costing

# Activity Based Cost Allocation

Let’s dig into activity based cost allocation. But first, we need to note that not all the allocation methods are based on the “cause and effect” concept. This is important because CEOs and other managers need to know what the real cost of a product or service is. Once that is known, two other considerations need to be addressed:

## Allocating Costs to Maximize Profits

The first question you need to ask is whether or not on any of the products or services have a negative income (after allocated fixed manufacturing costs). If so, the next question if whether or not eliminating/discontinuing those products or services will result in loss of profit. In other words, is any of your client’s other income a result of carrying that product or service? Or is there some other product or service that can replace that income source and increase profitability? If so, then eliminate the product or service so that you can increase the overall profitability.

If the answer is “no,” then you need to take a different approach. This approach involves assigning/allocating costs based on the ability to bear costs or some other equitable method. The goal for these methods is to keep the Board happy; so, the firm does not show any products or services that are losing money.  In addition, these methods need to find another way to maximize profit by incentivizing the sales staff to sell certain products. Accomplish this by allocating overhead in such a way that each sales person’s bonus or commission is tied to the products or services that maximize profit for the firm.

The most common approach used to allocate overhead (and joint costs) equitably is the relative sales value approach. It allocates overhead to products based on overall sales value. This approach works best in situations such as a full service hardware store that offers lumber, equipment and garden supplies. Chances are in a situation of that nature that the garden supply area would either break even or lose money if only based on its “cause and effect” share of overhead. Chances are that that department also contributes to the profitability of the other departments.

As a result, allocating the building overhead based on total revenues of each department would enhance the perceived profitability of the garden supplies department. Thus, your Board would be happy. Your CEO wouldn’t constantly explain that overhead is an allocated fixed cost. All that matters is overall profitability. Over, and over, and over again.

In conclusion, allocating costs can do more than save taxes under full costing. Use this as an additional service you can offer your clients to help them maximize their profits.

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## Can You Build Success by Narrowing Your Customer Base?

I recently read an interesting Business.com article by Art Saxby. Art Saxby is the founding principal of Chief Outsiders. In this article, he talks about how to achieve success by narrowing your customer base.  Sounds counter-intuitive… But how many firms tie up valuable resources catering to high-maintenance customers who often don’t stick around in the long run?

## Can You Build Success by Narrowing Your Customer Base?

Here’s an excerpt from the article:

Achieving success by narrowing your customer base?

It sounds counterintuitive, but many small- to mid-size businesses can achieve higher profits and more success by downsizing the base of customers they serve.

Creating the perfect situation in which you and your customer base share common goals, respect, and appreciation can alleviate personal and professional stress and allow your business to grow.

### Identifying Positive and Negative Customers

Some customers can boost your profits. Others can break your bank. If you don’t know which are which, you’re jeopardizing your business. Many companies could significantly increase profits overnight by either firing troublesome, unprofitable customers or ratcheting the price up so unprofitable customers leave or become profitable.

• Positive customers truly understand and appreciate what you do. They’re willing to work with you and pay a fair rate for the product or service they receive. When you compare the revenue you receive from these clients to the time spent for their continued business, you should find a fair and practical balance.

While every customer or client cares about price, your positive customers understand the value you bring to their businesses. You understand the issues they have with growing their businesses and you talk to them about ways you can help; they, therefore, understand and value what you do.

• Negative clients, on the other hand, can tax both your business’s operations and finances. For many companies, there’s a constant push to sell whatever can be sold to whoever will buy it. The business appears successful, and salespeople and operations stay busy in this scenario.

However, these customers can actually cost your company money, without really understanding or valuing the benefits of the product or service you provide. Your sales team might have lured these customers in with big price discounts or unrealistic delivery commitments to close the initial sale.

Negative customers often kill profitability by tying up valuable resources, like customer service time, engineering, or inventory. In many cases, these high-maintenance customers leave before you even recover your startup costs.

### When is it Time to Narrow Your Base?

One of the biggest clues that your company is spreading its net too broadly in terms of customer base is when most new sales are closed due to low prices and discounting. To sell to a wide audience, a product or service must have broad appeal.

However, if everybody likes your business, but nobody loves it, you are forced to compete on price. By trying to reach everyone, you meet a bit of everyone’s needs, but not enough of anyone’s specific needs for them to pay you a premium. It’s also possible you’ve loaded up your product/service with things customers don’t care about and aren’t willing to pay for.

### Analyze Your Sales Team’s Invested Time

Analyze your sales team’s invested time. This process can reveal which customers take up the majority of your business’s efforts. Often, a salesperson will cater to certain companies or segments and have specific product lines she likes to push. It’s a natural tendency to gear your efforts toward your interests, but this approach can really inhibit a company’s growth.

The likes and dislikes of a salesperson can actual control a company’s growth. If everyone is only focusing on what they consider their specialties, productivity and shared goals can suffer.

Focusing on price versus quality, and on isolated sales efforts versus a unified vision, can weaken your customer service and profit potential.

Companies can increase profitability by avoiding unprofitable customers. Clients only interested in price are often unfit for long-term business relationships.

The original article can be found here.

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## Supplier Power Definition

“In Porter’s five forces, supplier power refers to the pressure suppliers can exert on businesses by raising prices, lowering quality, or reducing availability of their products. When analyzing supplier power, the industry analysis is being conducted from the perspective of the industry firms. In this case, it is referred to as the buyers. According to Porter’s 5 forces industry analysis framework, supplier power, or the bargaining power of suppliers, is one of the forces that shape the competitive structure of an industry.

The idea is that the bargaining power of the supplier in an industry affects the competitive environment for the buyer. Furthermore, it influences the buyer’s ability to achieve profitability. Strong suppliers can pressure buyers by raising prices, lowering product quality, and reducing product availability. All of these things represent costs to the buyer. In addition, a strong supplier can make an industry more competitive and decrease profit potential for the buyer. On the other hand, a weak supplier, one who is at the mercy of the buyer in terms of quality and price, makes an industry less competitive and increases profit potential for the buyer….”

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