Lecture – Module 5 (Week 5)

Cost-Volume-Profit Analysis,
Budgeting & Management Control

Introduction to Accounting and Finance

(C37AF)
Dr Akira Yonekura
2023/24
Insights from “Guided Activity, Week 4”

Aim of the Activity:

• To deepen understanding of: -
– issues related to cost and cost management
– the interrelationship between costs and
contextual developments
Key Insights from the FT Article
High increases in the cost of raw materials,
packaging and transport affect companies (focus on
Unilever in the article), for example: -
– these increases in costs reduce the profit margin
– businesses need to develop strategies to offset
these costs
– costs need to be passed on to consumers
– share price is negatively affected
Key Insights from the YouTube Video
In the context of COVID the construction industry was
faced with rising cost.
Why?
– demand for new homes and remodeling and
refurbishing sharply increased
– demand for building materials, electrical goods
etc, increased which pushed up prices
– prices doubled and quadrupled
– cost of building and refurbishing increased
significantly
Insights from “Pre-work for Lecture, Week 5”

Aim of the Activity:

• to gain insights into the usage of budgets in a
business context
• to understand the link between cost
reduction/cost control and budgets
Argument:
• Paying attention to small items in the capital budget
and not just rubber-stamping them helps reduce
costs significantly.
• Paying attention to small items in the capital budget
is an alternative to reducing costs without laying off
people.
WHY?
• Small items in capital budgets make up around
80% of the capital budget.
 Overview of Lecture

• The use of costing information

• What is “Contribution”?
• Break-Even Point
• Cost-Volume-Profit Analysis (CVP) Analysis
• The Decision-Making, Planning and Control
Process
• Budgets and Management Control
 Costing and Decision Making

Use costing information to:

– Determine the contribution of units of products
– Levels of production to achieve a target profit
– Determine break-even point
– Set selling prices
– Set different selling prices for different customers
– Distinguish between different marketing strategies
– Decide on a make in house or buy in strategy
– Maximize short-term profits when resources are
scarce
 Contribution

• Contribution = the surplus that arises from

the production and sale of one unit of product
or service
• Contribution = selling price less the variable
costs of production
• Contributes to meeting an entity’s fixed
costs.
 Break-Even Point

• The number of units of production and sales that

will cover all the business’ costs both fixed and
variable
• Point at which revenue from sales = all the costs of
the business both fixed and variable
 Break-Even Point

Example:
Selling price per unit = £20 Break-Even Point = Total Fixed Costs
Variable cost per unit = £10 Contribution per Unit
Fixed costs = £30,000 of Sales

Break-Even Point = 30,000

Contribution = selling price – variable costs 10

Contribution = £20 - £10 Break-Even Point = 3,000 units

Contribution = £10
PROOF:
For 3,000 units:
Total Fixed costs …….... £30,000
Total Variable costs …… £30,000
Total Selling price ……… £60,000
Break-Even Point: Graphical
Illustration
 Break-Even Point & Target Profit

• Use break-even point to determine the

number of sales units required to meet a
target profit figure

Target profit
Sales units = + break-even sales units
contribution per unit

Example: Contribution per unit = £10

Selling price per unit = £20 Break-even sales units = 3,000
Variable cost per unit = £10
Fixed costs = £30,000
Target profit = £15,000 15,000
Sales units = + 3,000
10

Sales units = 1,500 + 3,000

Sales units = 4,500

 Margin of Safety

• The margin of safety indicates by how much

sales may decrease before a loss occurs.

Margin of Safety = Current level of sales - Break-even point

Example: 5,000 – 3,000 = 2,000 units

Expected Sales = 5,000 units
Break-even point = 3,000 units Margin of Safety = 2,000 units

Percentage Margin of Safety: expected sales – break-even sales

expected sales

Example: 5,000 – 3,000 = 40%

see above 5000
 Cost-Volume-Profit (CVP) Analysis
and Decision Making

What is CVP Analysis?

• A way of presenting financial information for decision

making.
• A systematic method of examining the relationship
between changes in activity (ie. output) and changes in
total sales revenue, expenses and net profit.
• CVP analysis studies the relationship between costs
(both fixed and variable), sales levels and profit.
 CVP Analysis can be used, for example, to
find answers to the following questions:

• How many units must be sold to break-even?

• What would be the effect on profits if we
reduce our selling price and sell more units?
• What sales volume is required to meet the
additional fixed charges arising from an
advertising campaign?
• Should we pay our sales people on the basis of
a salary only, or by a combination of salary and
sales commission?
 Example: Organising a Concert

SP = £20 per ticket

a = £30,000
b = £10 per ticket

1. Units to be sold to obtain a 2. Profit from the sale of

£15,000 target profit 4,000 tickets

P = SPx - (bx + a) P = SPxU - (bxU + a)

15,000 = 20x - (10x + 30,000) P = (4,000 x 20) - [(10 x 4,000) + 30,000]

15,000 = 20x - 10x - 30,000 P = 80,000 - (40,000 + 30,000)
15,000 + 30,000 = 20x - 10x P = 80,000 - 70,000
45,000 = 10x P = £10,000
4,500 Tickets
 Example: Organising a concert

SP = £20 per ticket

a = £30,000
b = £10 per ticket

3. Selling price to be charged to show a 4. Breakeven point in units

profit of £15,000 on sales of 4,000 units

P = SPxU - (bxU + a) P = SPx - (bx + a)

15,000 = 4,000x - [(10 x 4,000) + 30,000] 0 = 20x - (10x + 30,000)

15,000 = 4,000x - (40,000 + 30,000) 0 = 20x - 10x - 30,000
15,000 = 4,000x - 70,000 30,000 = 10x
15,000 + 70,000 = 4,000x
85,000 = 4,000x 3,000 = Break-Even Point in units

£21.25 = Price per ticket

 ASSUMPTIONS OF CVP ANALYSIS

• All variables other than the particular under

consideration remain constant.
• A single product or constant sales mix is
assumed.
• Total costs and total revenues are linear functions
of output.
• Costs can be accurately divided into their fixed and
variable elements.
• The analysis applies only to a short-term horizon..
The Decision-Making, Planning & Control Process

PLANNING PROCESS CONTROL PROCESS

1. Identify objectives 6. Compare actual and planned outcomes

2. Search for alternative courses of action 7. Respond to divergences from plan
3. Gather data about alternatives
4. Select alternative courses of action
5. Implement the decisions

BUDGETS
 What is a Budget?

Budget:
• the expression of a plan in quantitative (often
monetary) terms

“A budget is a quantitative statement, for a defined period

of time, which may include planned revenues, expenses,
assets, liabilities and cash flows. A budget provides a focus
for the organisation and aids the co-ordination of activities
and facilitates control”. (CIMA)
 BUDGETS and the BUDGETING PROCESS

The Objectives of Budgets The Budgeting Process

- Planning Step 1 Setting the Strategy and Deciding on

- Communication Selling Prices
- Coordination and Integration Step 2 The Sales Budget
- Control Step 3 Calculating the Direct Costs of Budegted
- Responsiility Sales
- Motivation Step 4 Setting the Budgets for Fixed Costs
Step 5 Drawing up the Budgeted Monthly
Statement of Profit and Loss
Step 6 Calculating Cash Receipts from Sales
Step 7 Calculating Cash Payments to Direct
Material Suppliers and Direct Labour
Step 8 Drawing up the Monthly Cash Budget
Step 9 Drawing up the Budgeted Statement of
Financial Position
 Budgeting, a part of the
Management Control System (MCS)

• Management has been described as the profession

of control, i.e. it is management’s role to manage
and co-ordinate all activities of an organisation so
as to ensure that the desired outcomes of the
organisation are achieved.
• Management is assisted by the Management
Control System (MCS)
• Management Accounting (e.g. budgeting) is part
of the MCS.
 Budgeting, a part of the Management
Control System (MCS)

• A budget is a point of comparison against which to

measure actual outcomes.
• A comparison of actual results against budgeted
results enables entities to control operations.
• Corrective action can be taken to eliminate
unfavourable divergences from the plan.
• Enhancement action can be taken to build upon
favourable divergences from the plan.
• This control process normally takes place on a
monthly basis.
Insights from “Guided Activity, Week 5”

• Aim of the Activity

– to deepen understanding of issues related to
budgeting
– to show that in the real world context there is
debate about what type of budgeting is best
suited for the business
Please note:
• This article discusses several issues that we
have not addressed in the lecture but it has
been chosen to give you some insights into the
issues that are discussed in practice and that
some of you might be studying later in their
management accounting courses.
Focus of the Article
• traditional as well as more modern budgeting
techniques
• interviews with CFOs and academics in
Switzerland to gain insights into: -
– their perceptions of traditional budgeting
– how they have improved their budgeting
processes and what new techniques they have
introduced (i.e. more modern and agile
budgeting techniques)
 End of the Accounting Part of C37AF

Please make sure you:

– have done all the Pre-Work Lecture tasks, Quizzes
and Guided Activities for weeks 1-5.
– you have read the relevant Chapters and Chapter
Sections of the Textbook, which discuss in more
detail the topics that have been covered in the
lectures.
 END OF LECTURE
Module 5 (Week 5)