What the Schwab/ TD Ameritrade Merger Teaches Us About The Cost-Volume-Profit (CVP) Ratio
Why would two large companies decide to merge?
In many cases, it has to do with huge changes in how both firms generate revenue and profits. As a business owner, you can use the cost-volume-profit (CVP) formula to make decisions about the direction of your business.
As this great article explains, Charles Schwab is merging with TD Ameritrade, two companies that control 11% of client assets in the retail financial services market. If you’re an investor, particularly a self-employed person who is funding retirement, you may have an account with one of these firms.
Both firms are well established in the investment industry.
Contents
Prior Success
Schwab has $3.8 trillion in client assets and over 12 million customer accounts. Similarly, TD Ameritrade has $1.3 trillion in client assets and 12 million customer accounts. Both companies are successful, and have national brand awareness.
So why pursue a merger?
The Revenue Issue
A major source of revenue is disappearing for both firms: fees from online trades.
Facing pressure from new competitors, like Robinhood, Schwab took the plunge and eliminated fees for online trades.
What happens when you give away something for free?
More people want it.
Sure enough, clients opened 142,000 new trading accounts in the first month alone.
The result? Schwab must now spend money to service 142,000 new accounts- and not earn any online trading fees.
Now, sure- Schwab is trying to bring more customers in the door, so the business can sell other products and services. But in the short term, it’s a money loser.
So, how do you maintain profitability when a major source of revenue goes away?
Merge, and cut expenses by eliminating duplicate costs.
The Merger
Combining firms allows the two companies to reduce both variable and fixed costs.
Tax expense, for example, is a variable cost that changes with the amount of profit a firm generates.
Schwab and TD Ameritrade will operate out of a single headquarters in Westlake, TX. Charles Schwab will stop paying the California corporate income tax, currently 8.84%, and operate in Texas, which has a 1% corporate income tax rate.
For most businesses, the biggest fixed cost is payroll.
The combined firms can eliminate duplication. Legal, accounting, and administrative jobs will certainly be reduced as two headquarters and combined into one.
Revenue for online trades has been eliminated, but the merger allows both firms to reduce fixed and variable costs.
The cost-volume-profit formula is a great tool to make similar decisions about revenue and costs.
Cost-Volume-Profit
Here’s cost-volume-profit (CVP) formula:
Profit = revenue less variable costs less fixed costs
Revenue is falling. One way for the merged firms to maintain (or even increase) profits is to lower variable costs and fixed costs.
You can also use the CVP formula to calculate breakeven:
In this case, assume that “X” represents units sold to reach breakeven. You’re selling a product for $50 a unit, your variable costs are $20 per unit, and fixed costs total $3,000. Set the profit to $0:
$0 Profit = $50X – $20X – $3,000
$3,000 = $30X
X = 100 units
If you sell 100 units at $50 per unit, you cover all of your costs.
You can also set the profit formula to reach a certain net income:
$3,000 Profit = $50X – $20X – $3,000
$6,000 = $30X
X = 200 units
To earn a $3,000 profit, you need to sell 200 units at $50 per unit.
The Lesson
CVP is a simple, “back of a napkin” tool you can use to perform what if analysis on your revenue, units sold, and costs.
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Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
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