DIRECTORATE OF DISTANCE EDUCATION

MBA – 1st seMester

Accounting for MAnAger
Unit 3 – Fund Flow and Cash Flow Analysis
Unit 4 – Marginal Costing and Cost Volume Profit Analysis

Presentation - 5 & 6 on 19-03-2022

Prepared & Presented by
Dr. V. Umasri,
Assistant Professor,
Directorate of Distance Education, Pondicherry
University
 Fund Flow Statement
MEANING
A fund flow statement is a statement prepared to analyse the reasons for changes
in the financial position of a company between two balance sheets. It portrays the
inflow and outflow of funds i.e. sources of funds and applications of funds for a
particular period. According to Foulke: “A statement of sources and application of
funds is a technical device, designed to analyze the changes in the financial
conditions of a business enterprise between two balance sheet dates.”
Funds Flow
Fund being working capital, Funds flow indicates the flow of working capital
between two points of time. It involves information relating to the various
transformations undergone by working capital (i.e. the changes that have taken
place in working capital) during the period involved between the two points of time.
Every change in working capital is associated with (or is on account of) a flow
either an inflow or an outflow. Thus, funds flow involves information relating to the
inflows and outflows that resulted in a change in working capital between the two
points of time.
Movement of Funds
 MANAGERIAL USES OF FUND FLOW STATEMENT
1. The foremost use of the fund flow statement is to explain the reasons for changes in the assets and liabilities
between two balance sheet dates.
2. Fund flow statement gives details about the funds obtained and used in past. Based upon this detail; manager
can take correct actions at appropriate times.
3. Fund flow statement acts as a control device when compared with budgeted figures. It also gives guidance to
the finance manager for taking remedial action if there is any deviation.
4. It helps the management to formulate various financial policies-viz dividend, bonus etc.
5. It gives guidance to the management with regard to working capital. Through fund flow statement,
management can take proper steps for effective utilization of surplus working capital or in case of inadequacy,
suitable arrangement can be made for improving the working capital position.
6. It identifies the strong and weak financial areas of the firm.
7. Effective utilization of available resources and scarce resources should be allocated according to the
preferential needs.
8. With the help of the fund flow statement, financial and lending institutions can easily evaluate the credit
worthiness and repaying capacity of the borrowing company.
9. It enables the management to reformulate the firm’s financial activity on the basis of the statement.
 LIMITATIONS OF FUND FLOW STATEMENT
1. In the real sense, the fund flow statement lacks originality because it is only a
rearrangement of data given in financial statements.
2. It indicates only the past year’s performance and is not for the future. Even to
prepare projected fund flow statement, it cannot show much accuracy.
3. It cannot reveal continuous changes. Because only any particular two years are
taken into account for analysis purpose.
4. Fund flow statement is not a substitute for a financial statement. It gives only
some information about changes in working capital alone.
 DIFFERENCE BETWEEN FUND FLOW ANALYSIS AND CASH FLOW ANALYSIS
1. Cash flow statement starts with the opening cash balance and ends with the closing cash balance by
processing through various sources and uses. But there is no opening and closing balances in fund flow
statement.
2. Cash from operation can be found out under the cash flow statement. But fund from operation can be
found out under the fund flow statement.
3. Separate statements are prepared for the purpose of finding out increase or decrease in working
capital under the fund flow statement. But no separate statements for increase or decrease in working
capital are prepared in cash flow analysis.
4. A cash flow statement explains the causes for the changes in cash and bank balances i.e., cash receipts
and cash payments alone. But fund flow statement indicates the causes for the changes in net working
capital.
5. Cash flow statement is suitable for short term financial planning and decision, while fund flow
statement is appropriate for long term financial planning and decisions.
6. Cash flow analysis deals with the movement of actual or notional cash. But fund flow statement deals
with not only cash but also the items constituting working capital. Cash is one of the components of
working capital.
7. Whenever, wherever there is inflow of cash there will definitely be inflow of funds. But sound fund
position need not be a sound cash position.
 STEPS IN PREPARATION OF FUND FLOW STATEMENT

1. Preparation of fund flow statement

2. Preparation of statement of changes in working capital.
3. Preparation of adjusted profits and loss account (to find out fund from
operation or fund lost in operation)
4. Adjustment and their treatment
5. Preparation of separate ledger
6. Treatment about the provision for taxation and proposed divider
NOTE: Fund flow statement alone is a major part of the solution; remaining other
things are supported to work the fund flow statement.
 1. Fund Flow Statement (Specimen form)
Amount Amount
Sources of Funds Application of Funds
Rs. Rs.
Issue of Equity Shares ---- Purchase of Fixed Assets ----
Issue of Preference shares ---- Purchase of Investments ----
Issue of Debentures ---- Redemption of shares ----
Loan borrowed ---- Redemption of debenture ----
Sale of Fixed Assets ---- Payment of loan ----
Sale of Investments ---- Payment of Tax ----
Non-trading incomes ---- Payment of Dividend ----
Fund from Operation (profit) ---- Non-trading losses ----

Decrease of working capital ---- Increase of working capital ----

Fund from operation (loss) ----

------- -------
 Proforma - Working Capital Statement
Particulars Previous Year Current Year Effect on Working Capital
Increase Decrease
Current Assets:
Cash on Hand ------- -------
Cash at Bank ------- -------
Sundry Debtors ------- -------
Bills Receivable ------- -------
Stock/ Inventory ------- -------
Prepaid Expenses ------- -------
Short-term Investments ------- -------
Outstanding Incomes ------- -------
Total Current Assets (A) ------- -------
Current Liabilities:
Sundry Creditors ------- -------
Bills Payable ------- -------
Bank Overdraft ------- -------
Outstanding Expenses ------- -------
Short-term Loan ------- -------
Prepaid Incomes ------- -------
Provision of Taxation * ------- -------
Total Current Liabilities (B) ------- -------
Net Working Capital (A - B) ------- -------
Net Increase / Decrease in Working Cap. ------- -------
TOTAL ------- -------

After the computation of working capital, we have to find out the increase
TAC - TCL =
or decrease in working capital.
WC
 Effect of working Capital
• Increase in the current year current assets than preVious year - Increase in Working Capital

Current Assets Working Capital

• Decrease in the current year current assets than previous year - Decrease in Working Capital
Working Capital
Current Assets

• Increase in the current year current liabilities than previous year - Decrease in Working Capital
Current Liability Working Capital

• Decrease in the current year current liabilities than previous year - Increase in Working Capital

Current Liability Working Capital

 Adjusted Profits and Loss account for the year ended
Particulars Amount Particulars Amount
To Non-Fund items (non-cash) By Balance b/d (opening balance)
Depreciation / Depletion By Non-Fund items (non-cash)
Loss on sale of fixed assets Interest received
Premium on redemption debentures and
Dividend received
preference shares
Discount on issue of shares and
Refund on taxes
debentures
Write off intangible assets (goodwill,
Profit on sale of fixed assets
patent, trade-mark)
Write off fictitious assets (preliminary
Change in stock (current assets)
exp., advertisement,)
To Appropriation / Provision
By Adjusted Profit
General reserve
(funds from operations)
Debenture sinking fund
Proposed dividend (equity and Preference
shares)
Interim dividend
Taxation provision
To balance C/f (Closing Balance)
 Important adjustments and their treatment
All the adjustments appear in two places :
Adjustment Treatment
1. Depreciation P.L. A/c debit side
Respective asset A/c credit side
2. Dividend paid P.L. A/c debit side
Fund flow statement-Application side
3. Income tax paid Income tax A/c debit side
Fund Flow Statement-Application side
4. Income tax provision P.L. A/c debit side
Income tax A/c credit side
5. Loss on sale of fixed Assets P.L . A/c debit side.
Respective asset A/c credit side.
6. Interim dividend paid P.L. A/c debit side
Fund flow statement-Application side.
Preparation of separate ledger A/c, if necessary i.e., about the non-current (either Assets or
Liability) items related information given in the adjustment means we have to prepare separate
ledger. Balances from this ledger can be transferred to fund flow statement means we have to
prepare a separate ledger. Balances from this ledger can be transferred to fund flow statement.
Treatment about the provision for taxation and proposed dividend
Provision for taxation and proposed dividend taken as current liability means it should appear
under working capital statement.
Some times, regarding the provision for taxation, information is given in the adjustment. So, it
should be treated as non current liability. Provision for taxation taken as non-current liability
means proposed dividend is also taken as a non-current liability.
(a) Treatment of provision for taxation
(i) Income Tax provided given in the adjustment, we have to find the tax paid-
P. L. A/c debit side
Income Tax A/c credit
(Balancing figure of taxation Ale is called tax paid and then it is transferred to Applications side
Problem – I: The following are the summaries of the balance sheets of the Bharat Vijay Ltd. as on 31-12-02 and 31-12-03.
The following additional information is obtained:
• The net profit for the year was Rs. 40,000 after charging depreciation.
• During the year depreciation charged was Rs. 30,000 on building and Rs. 40,000 on machinery.
• The company purchased during the year buildings worth Rs. 1, 60,000.
• Dividend paid during the year amounted to Rs. 20,000.
From the above information, prepare a statement of changes in working capital and statement of sources and application of funds for the year
2003.

2002 2003 2002 2003

Liabilities Assets
Rs. Rs. Rs. Rs.

Share capital 3,00,000 4,00,000 Buildings 1,20,000 2,50,000

Debentures 2,00,000 2,50,000 Machinery 3,00,000 2,60,000
Profit & Loss A/c 40,000 60,000 Stock 90,000 80,000

Creditors 70,000 80,000 Debtors 1,40,000 2,40,000

Bank overdraft 25,000 25,000 Prepaid expenses 15,000 25,000
Provision for Taxation 30,000 40,000

6,65,000 8,55,000 6,65,000 8,55,000

 STATEMENT OF CHANGES IN WORKING CAPITAL
INCREASE in DECREASE
PARTICULAR 2002 2003
W.C. in W.C.
Current Assets:
Stock 90,000 80,000 - 10,000
Debtors 1,40,000 2,40,000 1,00,000 -
Prepaid Expenses. 15,000 25,000 10,000 -
Total (A) 2,45,000 3,45,000
Current Liabilities:
Creditors 70,000 80,000 10,000
B.O.D. 25,000 25,000 - -
Provision for Taxation 30,000 40,000 - 10,000
Total (B) 1,25,000 1,45,000
Working Capital (A-B) 1,20,000 2,00,000
Increase in Working Capital 80,000 80,000
2,00,000 2,00,000 1,10,000 1,10,000

Fund Flow Statement

Sources of Funds Amount ₹ Applications/ Uses of Funds Amount ₹
Issue of Equity share capital 1,00,000 Purchase building 1,60,000
Debenture 50,000 Dividend Paid 20,000
Funds from operation 1,10,000 Increase in working capital 80,000
2,60,000 2,60,000
 Building A/c
Particular Amount ₹ Particular Amount ₹
Opening Bal 1,20,000 By Depreciation 30,000
To bank A/C- Purchase 1,60,000 By closing balance 2,50,000
2,80,000 2,80,000

Machinery A/c
Particular Amount ₹ Particular Amount ₹
To opening bal. 3,00,000 By Depreciation 40,000
By closing bal. 2,60,000

3,00,000 3,00,000

Adjusted Profit and Loss A/c

Particular Amount ₹ Particular Amount ₹
To Depreciation By opening bal 40,000
Building 30,000
Machinery 40,000 70,000
To Dividend Paid 20,000
To closing bal. 60,000 By Funds from Operation 1,10,000

1,50,000 1,50,000
 Problem – 2: From the following balance sheets of Bhairav Ltd. prepare:

1. A statement showing changes in working capital

2. A statement of source and application of funds.
Additional information:
• During the year taxes and interim dividend paid were Rs. 35,000 and Rs.
39,000 respectively.
• The assets of another company were purchased for Rs. 60,000 payable in fully
paid equity shares of the company. The assets consisted of stock Rs. 21,640,
plant Rs. 18,360 and remaining amount was for goodwill.
• During the year the purchase price is Rs. 5,650 for a plant.

Liabilities Rs. Rs. Assets Rs. Rs.

Creditors 39,520 41,135 Cash at bank 2,520 4,820
Bills payable 33,780 12,645 Debtors 85,175 72,625
Bank-overdraft 59,510 - Sundry Advances 2,315 735
Provision for taxation 40,000 50,000 Stock 1,11,040 97,370
Reserve 50,000 55,000 Land- building 1,48,500 1,44,250
P & L A/c 39,690 36,220 Plant 1,12,950 1,16,200
Equity shares capital 2,00,000 2,60,000 Goodwill - 19,000

4,62,500 4,55,000 4,62,500 4,55,000

 STATEMENT OF CHANGES IN WORKING CAPITAL
PARTICULAR 2010 2011 INCREASE in DECREASE in
W.C. W.C.
Current Assets
Stock 1,11,040 97,370
Less: Asset Purchase 21,640
( 2nd effect in Eq. share A/c.)
Correct Stock 1,11,040 75,730 35,310
Cash at bank 2,520 4,820 2,300
Sundry Advances 2,315 735 1,580
Debtors 85,175 72,625 12,550
Total(A) 201,050 1,53,910
Current Liabilities
Bills Payable 33,780 12,645 21,135 -
Creditors 39,520 41,135 1,615
B.O.D. 59,510 - 59,510 -
Total(B) 1,32,810 53,780
Working Capital(A-B) 68,240 1,00,130

Increase in Working Capital 31,890

82945 82945
 Fund Flow Statement
Sources of Funds Amount Application of Funds Amount
Purchase of machinery 5,650
Tax paid 35,000
Interim Dividend 39,000
Funds from Operation 1,11,540 Increase in working capital 31,890

1,11,540 1,11,540
Adjusted Profit & Loss Account
Particular Amount Particular Amount
To Provision for reverse 5,000 By bal b/d. 39,690
To goodwill written off 1,000
To provision for taxation 45,000 By Adjusted profit 1,11,540
TO interim Dividend 39,000
To dep. On land- building 4,250
To dep. On machinery 20,760
To bal c/f 36,220

1,51,230 1,51,230
 Equity share Capital Account
Particular Amount Particular Amount
By bal b/d. 2,00,000
By machinery 18,300
By Stock 21,640
By bal c/d 2,60,000 By G/W A/c. 20,060
2,60,000 2,60,000
Machinery Account
Particular Amount Particular Amount
To opening bal. 1,12,950 By profit & loss (Dep.) 20,760
To Machinery(business) 18,360
To bank (purchase) 5,650
By closing bal. 1,16,200
1,36,960 1,36,960
Provision for Taxation Account
Particular Amount Particular Amount
To tax paid 35,000 By Bal b/d 40,000
To bal. c/f 50,000 By profit & loss (provision) 45,000
85,000 85,000
 Cash Flow Statement
Cash flow statement is a statement which is prepared from the historical data showing the inflow and
outflow of cash. It shows the sources and uses of cash between the two balance sheet dates. It clearly
explains the causes for changes in cash position between two periods. Simply, it is a receipts and
payments account in a summary form.
Cash flow statement which classifies cash flows during the period from operating, investing and
financing activities. This statement provides relevant information in assessing a company’s liquidity,
quality of earnings and solvency.
Benefits:
1. Cash flow statement provides information about the changes in cash and cash equivalents of an
enterprise.
2. Identifies cash generated from trading operations.
3. The operating cash surplus which can be applied for investment in fixed assets.
4. Portion of cash from operations is used to pay dividend and tax and the other portion is ploughed
back.
5. Very useful tool of planning.
Purpose: Cash flow statements are prepared to explain the cash movements between two points of
time.
Cash and relevant terms as per AS-3 (revised)
As per AS-3 (revised) issued by the Accounting Standards Board
1.(a) Cash fund : Cash Fund includes (i) Cash in hand (ii) Demand deposits with banks, and
(iii) cash equivalents.
(b) Cash equivalents are short-term, highly liquid investments, readily convertible into cash
and which are subject to insignificant risk of changes in values.

2. Cash Flows are inflows and outflows of cash and cash equivalents.
The statement of cash flow shows three main categories of cash inflows and cash outflows,
namely : operating, investing and financing activities.
(a) Operating activities are the principal revenue generating activities of the enterprise.
(b) Investing activities include the acquisition and disposal of long- term assets and
other investments not included in cash equivalents.
(c) Financing activities are activities that result in change in the size and composition of
the owner’s capital (including Preference share capital in the case of a company) and
borrowings of the enterprise.
 Classification of Cash in-flows and outflows
From sales of goods and To wages salary
services to customers payments
From receipt of customer To suppliers for
advances purchases of inventories
Operating Activities
From receipt of interest To other operating
revenue or dividends or expenses
rent revenue or similar To interest payments
revenue items To tax payments
To advance payments to
suppliers
From sale of Fixed and To purchase Fixed and
other long-term assets other long-term assets
Investing Activities
From collection of loans To make loans and to
collect such loans

From sale of common or

preferred stock Financing Activities To repay debt
From issuance of short or To pay dividends
long term debt
 1. Cash Flow Statement (Specimen form) Indirect Method
Amount Amount
Inflow of Cash Outflow/Uses
Rs. Rs.
Opening Cash Balance ----- Cash from operation (loss)
Issue of Equity Shares ---- Purchase of Fixed Assets ----
Issue of Preference shares ---- Purchase of Investments ----
Issue of Debentures ---- Redemption of shares ----
Loan borrowed ---- Redemption of debenture ----
Sale of Fixed Assets ---- Payment of loan ----
Sale of Investments ---- Payment of Tax ----
Non-trading incomes ---- Payment of Dividend ----
Cash from Operation (profit) ---- Non-trading losses ----
Closing Cash Balance ----
----
------- -------
Preparation of Separate Ledger
If information of any particular assets or liabilities are given in the adjustment, we have to prepare
separate asset or liabilities account. Balances from this ledger can be transferred to cash flow
statement.
Treatment of adjustments
The additional information which are given apart from the balance sheet are, simply called as
adjustment. All the adjustments will appear in two places. The following are the important
adjustments and their treatment.
(a) Dividend paid – Cash flow statement – outflow side
– Profit & loss A/C – Debit side
(b) Depreciation – P.L.A/c- Debit side
(c) Loss on sale of Assets – P.L.A/c – Debit side
Respective asset A/c – credit side
(d) Income Tax – P.L.A/c – Debit side
Provision Income Tax – Credit side.
NOTE : The adjustments applicable for fund flow statements will also be applicable for cash flow
statements.
 PROB: 1
Following are the balance sheets of a Vijay & son: Prepare a cash flow statement.

• During the year Rs. 26,000 paid as dividend.

• The provision made for depreciation against machinery as on 1.1.05 was Rs.
27,000 and on 31.12.05 Rs 36,000.

Liabilities 1-1-05 31-12-05 Assets 1-1-05 31-12-05

Creditors 36,000 41,000 Cash 4,000 3,600

Loan from Partner - 20,000 Debtor 35,000 38,400

Loan from Bank 30,000 25,000 Stock 25,000 22,000

Capital 1,48,000 1,49,000 Land 20,000 30,000

Building 50,000 55,000
Machinery 80,000 86,000

2,14,000 2,35,000 2,14,000 2,35,000

 Cash From Operation
Particular Rs. Rs.
Net profit before tax 27,000
Add: Adjustment for dep. 9,000
36,000
Funds from Operation
5,000
Add: Inc. in current liabilities
Add: Decrease in stock 3,000
Less: Inc. in debtor 3,400
4600
Cash From Operation: 40,600
Cash Flow Statement for the year ended 31.12.2005
Sources of Cash Amount Applications/Uses Amount
Opening Cash balance 4,000 Purchase of land 10,000
Loan 20,000 Purchase of building. 5,000
Purchase of machinery 15,000
Repayment of bank loan 5,000
Payment of Dividends 26,000
3,600
Cash from Operation 40,600 Closing cash balance
64,600 64,600
 Workings:
Net profit before tax.
Capital (1.1.05) 1,48,000
1,49,00
Capital (31.12.05)
Diff. 1,000
Add. Dividends 26,000
Net Profit 27,000
Provision for Depreciation A/c
Particulars Rs Particulars Rs
To Balance c/d 36000
By Balance b/d 27,000

By Adjusted P & L A/c

(Depreciation) 9,000

36000
36000
Machinery Account
Particulars Rs Particulars Rs
To Balance b/d 80,000 By Depreciation 9,000

To Bank (purchase) 15,000 By Balance c/d 86,000

95,000 95,000
 PROB: 2
The summarized balance sheet of Bhadresh Ltd. as on 31.12.05 and 31.12.2006
are as follows:
Additional Details:
• Investment costing Rs. 8,000 were sold for Rs. 8,500
• Tax provision made during the year was Rs. 9,000
• During the year part of fixed assets costing Rs 10,000 was sold for Rs
12,000 and the profit was included in P & L A/c.
You are required to prepare cash flow statement for 2006.
Liabilities 2005 2006 Assets 2005 2006
Share capital 4,50,000 4,50,000 Fixed asset 4,00,000 3,20,000
General Reserve 3,00,000 3,10,000 Investment 50,000 60,000
P & l a/c 56,000 68,000 Stock 2,40,000 2,10,000
Creditors 1,68,000 1,34,000 Debtor 2,10,000 4,55,000
Tax provision 75,000 10,000 Bank 1,49,000 1,97,000

Mortgage loan - 2,70,000

10,49,000 12,42,000 10,49,000 12,42,000

 Cash Flow Statement

Sources of Cash Amount Applications/Uses Amount

1,49,000 Cash Lost in Operation 1,50,500

Opening Cash balance

Sale of investment 8,500 Purchase of Investment 18,000

Sale of Fixed assets 12,000

Loan 2,70,000
Payment of Tax 74,000

Closing cash balance 1,97,000

4,39,500 4,39,500
 Adjusted Profit & Loss A/c
Particulars Rs Particulars Rs
To Provision for tax
9,000 By Balance b/d 56,000
To Provision for G.R.
10,000 By Profit on sale of Inv. 500
To Depreciation
70,000 By Profit on sale of F.A. 2,000
To Balance c/d
68,000 By Adjusted Profit (Funds 98,500
from Operation)
1,57,000 1,57,000

Cash From Operation

Particular Rs. Rs.
Funds from Operation 98,500
Add: Dec. in stock 30,000
Less: Dec. in creditor 34,000
Less: Inc. in debtor 2,45,000 2,49,000

Cash Lost in Operation: 1,50,500

 Provision for tax A/c
Particulars Rs Particulars Rs

74,000 75,000
To Bank (tax paid ) 10,000 By Balance b/d 9,000
To Balance c/d By P & L A/c (provision)

84,000 84,000
 Investment A/c
Particulars Rs Particulars Rs

50,000
To Balance b/d 500 By Bank(sale) 8,500
To P & L A/c 18,000 60,000
To Bank (purchase) By Balance c/d

68,500 68,500
Fixed Assets A/C

Particular Rs Particulars Rs

To Balance b/d 4,00,000 By Bank a/c 12,000

To Profit and Loss a/c 2,000 By Dep. 70,000
By Balance c/d 3,20,000
4,02,000 4,02,000
Unit 4 – Marginal Costing and
Cost Volume Profit
Analysis
 Marginal Costing
Marginal costing is the ascertainment of marginal cost and of the effect on profit of
changes in volume or type of output by differentiating between fixed costs and variable
costs.
Marginal cost: The amount at any given volume of output by which aggregate variable
costs are changed if the volume of output is increased by one unit. In practice this is
measured by the total variable cost attributable to one unit. Marginal cost can precisely be
the sum of prime cost and variable overhead.
Marginal Cost = Variable Cost = Direct Labour + Direct Material + Direct Expenses +
Variable Overheads
Contribution: Contribution is the difference between sales value and the marginal cost
[Contribution (C) = Sales (S) – Variable Cost].
 DETERMINATIONOF COST AND PROFIT UNDER MARGINAL COSTING
For the determination of cost of a product or service under marginal costing, costs are classified into
variable and fixed. All the variable costs are part of product and services while fixed costs are charged
against contribution margin.
Cost and Profit Statement under Marginal Costing
Amount (`) Amount (`)
Revenue (A) xxx
Product Cost:
- Direct Materials xxx
- Direct employee (labour) xxx
- Direct expenses xxx
- Variable manufacturing overheads xxx
Product (Inventoriable) Costs (B) xxx xxx
Product Contribution Margin {A – B} xxx
- Variable Administration overheads xxx
- Variable Selling & Distribution overheads xxx xxx
Contribution Margin (C) xxx
Period Cost: (D)
Fixed Manufacturing expenses xxx
Fixed non-manufacturing expenses xxx xxx
Profit/ (loss) {C – D} xxx
 COST-VOLUME-PROFIT (CVP) ANALYSIS
Meaning: It is a managerial tool showing the relationship between various ingredients of profit planning viz., cost, selling
price and volume of activity. As the name suggests, cost volume profit (CVP) analysis is the analysis of three variables
cost, volume and profit. Such an analysis explores the relationship between costs, revenue, activity levels and the resulting
profit. It aims at measuring variations in cost and volume.
Impact of various changes on profit:
An understanding of CVP analysis is extremely useful to management in budgeting and profit planning. It elucidates the
impact of the following on the net profit:
(i) Changes in selling prices,
(ii) Changes in volume of sales,
(iii) Changes in variable cost,
(iv) Changes in fixed cost.
Marginal Cost Equation
The contribution theory explains the relationship between the variable cost and selling price. It tells us that selling price
minus variable cost of the units sold is the contribution towards fixed expenses and profit. If the contribution is equal to fixed
expenses, there will be no profit or loss and if it is less than fixed expenses, loss is incurred. Since the variable cost
varies in direct proportion to output, therefore if the firm does not produce any unit, the loss will be there to the extent of
fixed expenses. These points can be described with the help of following marginal cost equation:
1. Marginal Cost Equation = S-V = C = F±P/L
S= Selling Price per unit, V = Variable cost per unit, C= Contribution, F = Fixed Cost P = Profit/Loss
 Marginal Cost Statement
Sales xxxx
Less: Variable Cost xxxx
Contribution xxxx
Less: Fixed Cost xxxx
Profit xxxx

2. Contribution to Sales Ratio (Profit Volume Ratio or P/V ratio): This ratio shows the proportion of sales available to cover fixed costs
and profit. Contribution represent the sales revenue after deducting variable costs. This ratio is usually expressed in percentage.

A higher contribution to sales ratio implies that the rate of growth of contribution is faster than that of sales.
This is because, once the breakeven point is reached, profits shall grow at a faster rate when compared to a product with a lesser
contribution to sales ratio.

3. Break-Even Analysis: Break-even analysis is a generally used method to study the CVP analysis.
This technique can be explained in two ways:
(i) In narrow sense it is concerned with computing the break-even point. At this point of production level and sales
there will be no profit and loss i.e. total cost is equal to total sales revenue.
(ii) In broad sense this technique is used to determine the possible profit/loss at any given level of production or
sales.
Breakeven Point
This is the point where neither profits nor losses have been made is known as a break-even point. This implies that in order
to break even the amount of contribution generated should be exactly equal to the fixed costs incurred. Hence, if we know
how much contribution is generated from each unit sold we shall have sufficient information for computing the number of
units to be sold in order to break even.

Prob.1:Pepsi Company produces a single article. Following cost data is given about its product:-
Selling price per unit Rs.40
Marginal cost per unit Rs.24
Fixed cost per annum Rs. 16000 Calculate:
(a) P/V ratio (b) break even sales (c) sales to earn a profit of Rs. 2,000 (d) Profit at sales of Rs. 60,000 (e) New break even sales, if
price is reduced by 10%.
Solution:
We know that (S-v) /S= F + P OR S x P/V Ratio = Contribution So,
(A) P/V Ratio = Contribution/sales x 100
= (40-24)/40 x 100 = 16/40 x 100 = 40%
(B) Break even sales
Fixed Cost ÷ P/V Ratio or Fixed cost /contribution per unit
contribution per unit = sales - variable cost 40-24 = Rs.16
Fixed cost = 16,000 P/V ratio = 40%
BES = 16,000 / 40% = Rs. 40,000 OR 16,000/16 = BES in units = 1000 units
(C) The sales to earn a profit of Rs. 2,000
Fixed Cost + Expected Profit ÷ P/V Ratio (16,000+ 2000 )÷ 40% = Rs. 45,000)
Rs. 45,000/40 = 1,125 units

(D) Profit at sales of 60,000

S x P/V Ratio = contribution - F = P
Putting this values: Rs. 60,000 x 40/100 = 16000 - Fixed cost

24,000 – 16,000 = P
P = 8,000
(E) New break even sales, if sale price is reduced by 10% New sales price = 40-10% = 40-4 = 36
Sales = 36 Marginal cost = Rs. 24 36-24 = Contribution = Rs.
12
P/V Ratio = Contribution/Sales
New P/V ratio = 12/36 x100 OR 33.33%
Now, s x P/V Ratio = F
(at B.E.P. contribution is equal to fixed cost) S x 100/300 = Rs.16000
S = 16000 x 33.33% = Rs.48,000.
Prob.2: From the following information find out:
a. P/V Ratio
b. Sales
c. Margin of Safety
Fixed Cost = Rs.40, 000 Profit = Rs. 20,000 B.E.P. =
Rs. 80,000

Solution:
a. P/V Ratio.
We know that S – V = F + P OR S(S – V)/S = F + P Fixed cost / PV ratio = 80,000
40,000/PV = 80,000 P/V ratio =
B.E.S. x P/V Ratio = F (Value of P is zero at BE Sales) OR BES = Fixed cost/ P/V Ratio P/V Ratio =
F/BES Putting the value,
P/V Ratio = 40,000/80,000 = 50/100 OR 50%

b. Sales.
We know that Sales x P/V Ratio = F+ P OR Sales x P/V Ratio = Contribution OR Sales =
Contribution/P/V Ratio
So, = (40,000 + 20,000)/50/100
= (60,000 x 100)/50
=Rs.1, 20,000
c. Margin of Safety.
Margin of Safety = Sales – B.E.P Sales So, MOS = 1, 20,000 – 80,000
MOS = Rs.40, 000
Prob.3: You are given the following data :
Sales Profit Year Sales Profit
Year 2010 1,20,000 8,000
Year 2011 1,40,000 13,000 2010 1,20,000 8,000
Find out –
(i) P/V ratio,
2011 1,40,000 13,000
(ii) B.E. Point,
(iii) Profit when sales are `1,80,000,
(iv) Sales required earn a profit of `12,000, Difference 20,000 5,000
(v) Margin of safety in year 2011.

(i) P/V Ratio = Change in Profit /Change in Sales*

100
13,000-8000 /140,000-120,000 = 5,000/20,000 *100 (iv) Sales to earn a profit of 12,000
= 25% Fixed Cost+ Expected Profit /P/V ratio
(ii) BE Point = Fixed cost / P/V ratio
Fixed cost = Contribution – Profit 22,000 + 12,000/25% = 1,36,000
Contribution = Sales * P/V ratio (v) Margin of safety in 2011
= 1,20,000*25% = 30,000 (you may take any year sales)
30,000 – 8000 = 22,000 Fixed cost
Margin of safety = Actual sales – Break-even
BES = 22,000/25% = Rs. 88,000 sales
(iii) Profit when sales are Rs. 1,80,000 Rs.
= 1,40,000 – 88,000 = 52,000.

Contribution (`1,80,000 X 25%) 45,000

Less: Fixed cost 22,000
Profit 23,000
 APPLICATION OF CVP ANALYSIS IN DECISION MAKING
Management uses marginal costing and CVP concepts for making various decisions.
1. Profit Planning: Profit planning is the planning of future operations to attain maximum profit.
2. Pricing of Products
3. Selection of Product Mix
4. Problem of Key/Limiting Factor
5. Make-or-Buy Decision
6. Accepting Additional Orders and Exploring Foreign Market
7. Shut Down/Suspending Activities
Prob.4: A company has a machine No. 9 which can produce either product A or B. The cost data relating to machine A and B are as
follows:

Particulars Product A Product B

Selling price Rs. 20.00 Rs. 30.00
Variable expenses Rs. 14.00 Rs. 18.00
Contribution Rs. 6.00 Rs. 12.00

Additional Information:
a. Capacity of machine No. 9 is 1, 000 hrs.
b. In one hrs machine No. 9 can produce 3 units of A and 1 unit of B.
Which product should machine No. 9 produced?
 Solution:
Statement showing contribution per hour for machine No. 9
Product Product
Particulars
A B
Sales 20.00 30.00
Variable expenses 14.00 18.00
Contribution per unit 6 12
Contribution per hour Rs. 6 X 3 units 18.00 12.00
Contribution for 1,000 hrs 18,000 12,000

From the above table we can see that company should produce product A with the help of machine No. 9.

Prob.5: Meet & company Ltd. has three divisions each of which makes a different product. The budgeted data for the next year is as
follows: The management is considering closing down division C. There is no possibility of reducing variable costs. Advice whether or not
division C should be closed down.
Solution: Marginal Costs Statement
Divisions A B C
Division A B C
Rs. Rs. Rs.
Rs. Rs, Rs.
Sales 1, 12, 000 56, 000 84, 000
Sales 1, 12, 000 56, 000 84, 000
Direct material 14, 000 7, 000 14, 000
Marginal cost (Direct Material + Direct 33, 600 21, 000 64, 400
Direct labor 5, 600 7, 000 22, 400
Cost + Variable overheads)
Variable overhead 14, 000 7, 000 28, 000
Contribution 78, 400 35, 000 19, 600
Fixed cost 28, 000 14, 000 28, 000
Fixed cost 28, 000 14, 000 28, 000
Total cost 61, 600 35, 000 92, 400
Profit 50, 400 21, 000 (8, 400)

Advice: Division C’s Contribution is Rs.19,600, if the company can raise sales in division C, there is a possibility of earning
profit, if not the company may go for shut down the division of C
Prob.6: The following budget has been prepared at 70% level of home market:
Units - 4, 200 Rs.
Wages - 12, 600
Materials - 21, 000
Fixed cost - 7, 000
Variables cost - 2, 100
Total - 42, 700
The selling price in India is Rs. 15. In Sri Lanka about 800 units may be sold only at Rs. 10 and in addition 25 paise per unit will be expenses
as freight etc., Do you advise trying for the market in the Sri Lanka?

Solution: Marginal Cost Statement

India Sri Lanka Total
Particulars
(4200 units) (800 units) (5000 units)
Rs. Rs. Rs.
Sales (units x price) (A) 63, 000 8, 000 71, 000
Materials (Rs. 5 per unit) 21, 000 4, 000 25, 000
Wages (Rs. 3 per unit) 12, 600 2, 400 15, 000
Variables(Rs. 0.50 per unit) 2, 100 400 2, 500
Freight (Only for Sri Lanka Rs. 0.25 per unit) ----------- 200 200
Marginal cost (B) 35, 700 7, 000 42, 700
Contribution (A – B ) 27, 300 1, 000 28, 300
Less: Fixed cost 7, 000 --------- 7, 000
20, 300 1, 000 21, 300
Suggestion: It is advisable to try for the Sri Lankan market at Rs. 10 per unit as by doing so
there is an increase of Rs. 1000.
Prob.7: The cost analysis of two products A and B is given below:
Particulars Product A Product B
Rs. Rs.
Material Rs. 2.50 per unit 25 45
Labor @ Rs. 1 per hour 12 ---
Labor @ Rs. 1.50 per hour --- 15
Variable overheads 2 5
Selling price 70 80
On the basis of above information, which product would you recommend to be manufactured if labor is key factor and if material is key
factor?
Solution: Here first of all we have to find out contribution on the basis of both, material as a key factor and labor as a key
factor.
Statement showing marginal cost and contribution
Particulars Product A Product B
Rs. Rs.
Selling price(A) 70 80
Material 25 45
Labor 12 15
Overheads 2 5
Marginal cost (B) 39 65
Contribution (A – B) 31 15
31/10 units = 3.10 15/18 units = 0.83
Contribution per unit of Material
(25 units/ 2.50 = 10 units) (45 units/ 2.50 = 18 units)
0.258 1.50
Contribution per labor Hour
(31/12 hrs) (15/10 hrs)
Advise: If labor is key factor then product B and if material is key factor then product A should be produced