Break-Even and Cost-Volume-Revenue Analysis for Nonprofit Organizations

By Shim, Jae K. | Academy of Accounting and Financial Studies Journal, January 1997 | Go to article overview

Break-Even and Cost-Volume-Revenue Analysis for Nonprofit Organizations


Shim, Jae K., Academy of Accounting and Financial Studies Journal


QUESTIONS ANSWERED BY CVR ANALYSIS

CVR analysis tries to answer the following questions:

(a) What service level (or units of service) is required to break even?

(b) How would changes in price, variable costs, fixed costs, and service volume affect a surplus?

(c) How do changes in program levels and mix affect aggregate surplus/deficit?

(d) What alternative break-even strategies are available?

ANALYSIS OF REVENUES

Revenues for nonprofit entities include grants, contributions, and membership fees. For managerial purposes, each type of revenue is grouped into its fixed and variable parts. Fixed revenues are those that remain unchanged regardless of the level of service, such as gifts, grants, and contracts. For example, in colleges, donations, gifts, and grants have no relationship to enrollment. Variable revenues are the ones that vary in proportion to the volume of activity. Examples are cost reimbursements and membership fees. In colleges, tuition and fees are variable in relation to the number of students. Different nonprofit entities may have different sources of revenue: variable revenue only, fixed revenue only, or a combination of both. In this chapter, we will cover different cases in treating break-even and CVR questions.

ANALYSIS OF COST BEHAVIOR

For managerial purposes (such as planning, control, and decision making), further classification of costs is desirable. One such classification is by behavior. Depending on how a cost will react or respond to changes in the level of activity, costs may be viewed as variable or fixed. This classification is made within a specified range of activity, called the relevant range. The relevant range is the volume zone within which the behavior of variable costs, fixed costs, and prices can be predicted with reasonable accuracy. Variable costs vary in total with changes in volume or level of activity. Examples of variable costs include supplies, printing and publications, telephone, and postage and shipping. Fixed costs do not change in total regardless of the volume or level of activity. Examples include salaries, accounting and consulting fees, and depreciation.

CVR ANALYSIS WITH VARIABLE REVENUE ONLY

For accurate CVR analysis, a distinction must be made between costs as being either variable or fixed. In order to compute the break-even point and perform various CVR analyses, note the following important concepts. The contribution margin (CM) is the excess of revenue(R) over the variable costs (VC) of the service. It is the amount of money available to cover fixed costs (FC) and to generate surplus. Symbolically, CM = R- VC. The unit CM is the excess of the unit price (P) over the unit variable cost (V). Symbolically, unit CM = P - V. The CM ratio is the contribution margin as a percentage of revenue.

EXAMPLE 1

To illustrate the various concepts of CM, assume that Los Altos Community Hospital has an average revenue of $250 per patient day. Variable costs are $50 per patient day. Total fixed costs per year are $650,000. Expected number of patient days is 4,000. The projected statement of revenue and expenditures follows:

                        Total         Per Unit   Percentage

Revenue (4,000 days)    $1,000,000    $250       100%
Less: Variable costs    200,000       50         20
Contribution margin     $800,000      $200       80%
Less: Fixed costs       650,000
Net income              150,000

BREAK-EVEN ANALYSIS

The break-even point represents the level of revenue that equals the total of the variable and fixed costs for a given volume of output service at a particular capacity use rate. Generally, the lower the break-even point, the higher the surplus and the less the operating risk, other things being equal. The break-even point also provides nonprofit managers with insights into surplus/deficit planning. …

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