Business Analysis: Cost-Volume-Profit, Variances, and Decision Metrics
Business analysis for the BAR exam rewards fluency with a handful of interlocking models rather than memorized formulas. Start with cost behavior: separate fixed from variable costs, compute contribution margin (CM = price − variable cost per unit), and use the CM ratio for break-even in sales dollars (fixed costs ÷ CM ratio). Target profit adds the desired profit to fixed costs in the numerator; after-tax targets require dividing by (1 − tax rate) first. Margin of safety is budgeted sales minus break-even sales, often expressed as a percentage.
Variance analysis is the second pillar. The material price variance is (standard price − actual price) × actual quantity purchased, while the material quantity variance is (standard quantity allowed − actual quantity used) × standard price. Favorable means actual cost was below standard, not that the outcome was good in a business sense. The trap: using actual quantity purchased in the quantity variance, or flipping which quantity each variance multiplies. Labor and overhead follow the same structure (rate/efficiency, spending/efficiency, volume).
For decision-making, apply relevant-cost thinking: ignore sunk costs and allocated fixed costs that do not change, and include opportunity costs. Special-order, make-or-buy, and keep-or-drop questions hinge on this. Capital budgeting adds net present value (accept if positive), internal rate of return (accept if it exceeds the hurdle rate), payback, and accounting rate of return-only NPV and IRR use discounted cash flows, and depreciation is not a cash flow except for its tax shield.
Worked rule of thumb: a product shows sales of $100, variable costs of $60, and avoidable fixed costs of $25. Its segment margin is $15, so dropping it destroys $15 of profit even if allocated common costs make it look unprofitable.