COST VOLUME PROFIT EXPANDED:

ANALYSIS (SP X SALES VOL) – (UNIT VC X SALES VOL) – TFC

= PROFIT
CHAPTER 4
CVP ANALYSIS
BREAK-EVEN ANALYSIS
- key factor in planning and controlling, and
- Shows the breakeven point before interest
undoubtedly, the best tool to profit maximization.
charges.
- study of the effects of volume of output on
- Shows the magnitude of the firm’s profits or losses
revenues, expenses, and net income.
if sales exceed or fall below the break-even point.
- analytical technique for studying the relationship
between fixed costs, Variable costs, sales volume
THIS WOULD HELP MANAGEMENT DETERMINE
and profits.
 The number of unit sales required to break even
 The peso amount of needed to achieve a profit
BREAKEVEN POINT IN CVP ANALYSIS
level
 The effect on profits if selling price, fixed cost,
BREAK-EVEN POINT
and variable cost changes
- is the point at which total sales will just cover total
 The required selling price needed to cover a
costs – that it will only breakeven - no profit, no
fixed cost change
loss. NI = 0
UNDERLYING ASSUMPTION
it is assumed that mixed costs have been
 Relevant range - CVP analysis is valid only
segregated already as to its variable and fixed
within the company's relevant range of
components using the different cost segregation
activity. If an activity was made beyond this
techniques, which the management thinks would
point the relationship of fixed cost and
be the most applicable method for their situation.
variable costs may vary
 Cost behavior identified - Costs are
variable costs real VC + variable portion of the
classified as to fixed and variable only, no
mixed costs as segregated
more mixed cost, as mixed cost was assumed
FIXED COSTS real FC + the fixed portion of the to have been segregated already using any
mixed costs. cost segregation method
 Linearity - The selling price and the unit
INTEREST variable cost are constant overall sales
- is a financial cost as opposed to an operating cost. volumes within the company's relevant range
Concerned with the firms operating plan rather of activity
than its financing plan.  Sales and production volume are equal -
interest charges - is not included in the examples. If sales and production are not equal, some
amount of variable and fixed costs is treated
BASIC CVP TERMS:
as assets (inventories) rather than expense. If
 Break-even point - The point where there is no
inventories remain stable between adjacent
profit, no loss. TOTAL SALES = TOTAL COST
time periods, there will be no significant effect
 Contribution margin - SALES – VARIABLE on the CVP analysis. Thus, CVP assumes no
COST beginning, no ending inventory.
 Contribution margin ratio – CONTRI MARGIN /  Activity measure - The only cost driver is
total sales or SP the volume of units produced.
 Contribution margin per unit – SP per unit –  Constant sales mix - In a multiple product
VC per unit line, the sales mix is assumed to be constant
 Margin of safety - the excess of actual or throughout the year
budgeted sales over break-even sales. It is the
amount by which sales could decrease before
losses may occur. USES OF CVP ANALYSIS
Actual or budgeted sales – BE sales  provide with cost and profit data for profit
 Margin of safety ratio - Margin of safety / planning, policy, formulation, and decision
making.
actual or budgeted sales, or profit ratio /
 provide data in the optimal level and mix of
contribution margin ratio.
output to be produced with available
 Relevant range - Limit within which the volume
resources.
of activity can vary where sales and costs
 help the two pre-determine the required
relationship remain valid
volume of production and desired profit
 Sales mix - the relative combination of products
that compose a company's total sales This is
applicable only in a multiple product line company
BREAK-EVEN POINT FORMULAS
BASIC CVP EQUATION:
SALES – VC = CM – TOTAL FC = PROFIT
Single product line:
Contribution Margin Equation approach: a. Breakeven point in monthly sales of Angie
BEP = SALES – VC – FC BEP in units = FC / UNIT CM
TMC = SALES IN UNITS X CM PER UNIT = 54,000 / (25 -10 -5 -2.50 -2.50)
# of units sold = CM / CM per unit 10,800 units = 54,000 / 5
BEP , FC = CM
BEP in pesos = FC / CM RATIO
CM approach:
P270,000 = 54,000 / 20%
BEP IN UNITS = TFC / CM PER UNIT
BEP IN PESOS = TFC / CM RATIO
CMR = CM / SP = (25 - 20) / 25 = 20%
DESIRED SALES To check: 10,800 units x P25 = P270,000

Net income before income tax b. Net income using the equation approach
DS IN UNITS = TFC + DESIRED PRE-TAX PROFIT PRE-TAX PROFIT = (SP X SV) – (UNIT VC X SV) – TFC
CM PER UNIT
P6,000 = (25 x 12,000) – (20 x 12,000) – 54,000
DS IN PESOS = TFC + DESIRED PRE-TAX PROFIT
CM PER RATIO Or PROFIT = SALES – VC = CM - TFC
Net income after income tax P6,000 = 300,000 – 240,000 – 54,000
DS IN UNITS = TFC + DESIRED PROFIT AFTER
TAX/1– TAX RATE c. Margin of safety
CM PER UNIT MS in pesos = T SALES(ACTUAL OR BUDGT) - BE IN
DS IN PESOS=TFC + DESIRED PROFIT AFTER PES0
TAX/1– TAX RATE P30,000 = 300,000 – 270,000
CM PER RATIO MS in units = T SALES IN UNITS – BE IN UNITS
1,200 units = 12,000 – 10,800 units

For example:
d. Margin of safety ratio
Angels and Dolls Company plans to introduce a new MS ratio = MS / TOTAL SALES
doll called Angie in September. Information on 10% = 30,000 / 300,000
estimated selling price and related costs for Angie is
shown below. e. Profit using MS and CMR
Profit = MS x CMR
Selling price per unit P25 P6,000 = 30,000 x 0.20
Variable cost per unit
DM 10
Note: the contribution margin from the margin of
DL 5 safety sales will be the profit because at breakeven
Manufacturing support costs 2.50 point, the total fixed costs have been recovered
Sales commission 2.50 already and the contribution margin in the excess
Monthly fixed costs: sales will become the profit.
Manufacturing support costs 20,000
f. How many units of Angie must be sold to
General S&A 34,000 earn a profit of P8,000 before tax or pre-
Actual units produced 12,000 tax?
DS in units = TFC + DESIRED PRE- TAX PROFIT
12,400 units = 54,000 + 8,000 / 5
FACTORS ON HOW PROFITS ARE AFFECTED DS in pesos = DS IN UNITS x SP
1. Selling prices P310,000 = 12,400 X 25 OR 54,00 + 8,000 / 0.20
2. Sales Volume
3. Variable cost per unit
4. Total fixed costs g. How many units of Angie must be sold to
5. Product mix earn a profit of P8,000 after tax and
assume further a tax rate of 20%?
KEY ASSUMPTION IN CVP ANALYSIS DS in units = TFC + [D PROFIT AFTER TAX / (1-TAX
1. Costs are classified as variable or fixed
RATE)]
2. Variable costs change at a linear rate
3. Fixed costs remain unchanged within the CM PER UNIT
relevant range = 54,000 + [8,000 / (1 – 0.20)] /
4. Selling prices do not change as sales volume 5
Changes 12,800 units = 54,000 + 10,000 / 5
5. For multiple product companies, sales mix DS in PESOS = TFC + [D PROFIT AFTER TAX / (1-
usually remains constant
TAX RATE)]
6. Inventory levels remain constant and is not
focused too much in CVP analysis CM RATIO
7. Volume is the greatest factor affecting costs P320,000 = 54,000 + 10,000 / 0.20 OR
Required: 12,800 X 25
 BREAK – EVEN CHART STEPS: determine
 SM Sales mix or set the planned sales mix.
 CM Contribution Margin for each product.
 WCM Weighted Contribution Margin per unit =
Number of units in the mix for each product
X each corresponding CM per unit
 TWCM Get the sum of the WCM per unit to get the
Total Weighted Contribution & considers that as
the single CM per unit.
 CU Combined units = TFC / TWC.
If the amount to be determined is the Desired sales
with profit, the same approach will be done,
except that the numerator will be TFC + the
desired profit
 CU derived from step 5 x # of each product in
mix.

For example:
Breakeven point ~ Total sales and cost line intersect
No profit or loss ~ total revenue and total cost (TFC & Assume that the company produces 2 types of
TVC) products, A and B, which are using the same
are equal facilities. The company plans to produce 2 units of A
profit area ~ portion beyond the BEP where the total and 3 units of B. Product A has a Contribution margin
revenue line is higher than the total costs line is the. of P4 per unit while B has P12. The company's fixed
LOSS AREA ~ portion before the BEP where the total cost is P420,000
cost line is higher than the total revenue line
Required: Determine the BEP in units & sales
The user of the chart could easily point out how
many units and peso sales must be sold in order Produc S CM/u WCM/u CU BEP
to breakeven or to realize a profit. t M (b x c) in
units
PROFIT VOLUME GRAPH (b x
e)
a b c d e f

A 2 P4.0 P8.00 30,00 60,00

0 0 0
B 3 P2.0 P6.00 30,00 90,00
0 0 0
TWCM P14.00
Total Sales 150,000
CU = 420,00 / 14 30,000 times
TCM
A 60,000 x 4 240,000
+B 90,000 x 2 180,000
420,000
- FC (420,000)
BEP P0

Note: BEP & TCM always = TFC

used to easily determine the total number of units
If proportions of the mix the CVP relationships also
where the company has profit or loss.
change. For instance, X Company has two S, A and B.
The budgeted income was presented:
BREAKEVEN POINT FOR MULTIPLE PRODUCT
LINE
A B TOTAL
Sales in units 120,000 30,000 150,000
The company must pre-determine the sales mix
P960,00 P150,00 P1,110,0
where such sales mix will be considered as one Sales @ 8 & 5 0 0 00
package (composite unit) as in a single product line. VC @ 7 & 3 (840,00 (90,000 (930,000)
0) )
 CM A=1 B=2 P120,00 P60,000 P180,000
0 COST STRUCTURE
FC (90,000) - Important in profit planning
NI P90,000 - Relative portion of its FC & VC
- Vary among industries and among firms w/in the
industry
To determine the BEP, ignoring income taxes, - Has significant effect on the sensitivity of its
computations would assume a constant mix of 4 profit to changes in volume
units of A for every unit of B. For simplicity,
computation would be, let X = number of units of
product B to breakeven, and 4X number of units of VARIABLE COSTING FORMULA:
product A to break even. Thus, Sales (xxx)
Less: Variable Costs (xxx)
SALES – VC – FC = ZERO NET INCOME Contribution Margin xxx
Less: Fixed Costs (xxx)
P8(4X) + P5(X) – P7(4X) – P3(X) – =0 Net Income xxx
90,000
32X + 5X – 28X – 3X – 90,000 =0 Company A B C
Amoun % Amoun % Amoun %
6X – 90,000 = t t t
P6X 90,000 Sales 500,000 10 500,000 10 500,000 10
0 0 0
X = B VC 300,000 60 400,000 80 50,000 10
15,000 CM 200,000 40 100,000 20 450,000 90
FC 150,000 30 50,000 10 400,000 80
4X = A NI 50,000 10 50,000 10 50,000 10
60,000
To prove Notice that the three companies have the same sales revenues and
Product A (8 - 7) x 60,000 = net incomes, however, they have different cost distribution. Company
60,000 B's cost structure is dominated by variable costs. It has a very low
contribution margin ratio of 20 percent. In contrast, Company C's cost
Product B (5 – 3) x 15,000 30,000
structure is dominated by fixed costs. Its contribution margin ratio is
Total 90,000 90 percent. Company A is in between these two extremes with a
Less: Fixed costs 90,000 contribution margin ratio of 40 percent. These costs’ structure is
Breakeven 0 significant in analyzing changes in revenues. Suppose sales revenue
increases by 10 percent or P50,000 in each company. The resulting
BEP for a sales mix of 4 units of A for every unit of increase in each company's profits can be computed as follows:
B
Inc sales revenue Inc NI / SALES %
X
BEP = FC / CM per unit
CMR
Only B were sold
A 50,000 X 40% = 20,000 / 50,000 4
90,000 / 2 = 45,000 units of B
0
Only A were sold
B 50,000 X 20% = 10,000 / 50,000 2
90,000 / 1 = 90,000 units of A
0
C 50,000 X 90% = 45,000 / 50,000 9
Sales mix change = BEP & NI @ sales level are 0
altered
Notice again that Company B, with its high variable expenses and low
contribution margin ratio, shows a relatively low percentage increase
in profit. In contrast, the high fixed expenses and large contribution
SOME LIMITATIONS OF BREAKEVEN ANALYSIS
margin ratio of Company C resulted in a relatively high percentage
increase in profit. Company A remains to be in between these two
 The total revenue function assumes that the extremes. Notice also that the percentage increase in net income is
price per units meant regardless of the equal to the contribution margin ratio.
volume of sales and production, which is The greater the proportion of fixed costs in a firm's cost structure, the
normally, not realistic. If demand is high, the greater will be the impact on profit from a given percentage change
firm could have the best chance to increase in sales revenue. Examine the profit picture after the change in sales.
Company C now has the highest profit.
price and improve profit margin.
 Is it realistic to expect VC per unit to be Company A B C
constant at all output level? Amoun % Amoun % Amoun %
t t t
Sales 550,000 10 550,000 10 550,000 10
Breakeven analysis could be expanded, and the cost curve would 0 0 0
change from linear to non-linear. This situation might exist where the VC 330,000 60 440,000 80 55,000 10
CM 220,000 40 110,000 20 495,000 90
firm has a loss at low sales volume, earns a profit over some range of FC 150,000 27 50,000 9 400,000 72
sales volumes, and then has a net loss at a very high sales volume. NI 70,000 13 60,000 11 95,000 18

The firm might also want to consider changing its level of fixed costs. Using the above illustration, Company B would show a low operating
Higher fixed costs are not good, other things held constant. Higher leverage, Company C has high operating leverage, and Company A
fixed costs are associated with a more mechanized or automated falls in between.
processes, however, it reduces variable costs per unit. Profit under
different production setups and price cost situations could be best
presented and analyzed using the cost structure and operating
OPERATING LEVERAGE
leverage.
 - The extent to which an organization uses fixed High OL (affects BEP) = High Fixed expenses = High
costs in its cost structure is called in firms with a BEP
large proportion of fixed operating leverage.
- are greatest costs, low proportion of variable
costs, and the resulting high contribution margin FIXED EXPENSES / BREAKEVEN SALES
REVENUE
ratio. If a high percentage of a firm's total costs CMR
are fixed, the firm is said to have a high degree A 200,000 / 50,000 X = 375,000
40%
of operating leverage.
B 100,000 / 50,000 X = 250,000
- To the management accountant, it refers to the
20%
ability of the firm to generate an increase in net C 450,000 / 50,000 X = 444,000 highest
income when sales revenue increases. It is the 90%
firm's ratio of fixed costs to variable costs.

LEVERAGE
High FC = High OL ~ firm can generate a large
- it refers to the ability of a small force to move a
percentage increase in net income from a relatively
heavy weight; as in physics, leverage implies the
small percentage increase in sales revenue
use of a lever to raise a heavy object with a small
High OL = High BEP ~ some risk to the firm
amount of force. As the saying goes, "people who
have leverage can accomplish a great deal with  breakeven point, cost structure, and operating
their smallest word or action," or the so-called leverage were on the establish equations and
"significant influence". straight-line graph, which means that price is
constant, that fixed costs have been established
In business, a high degree of operating leverage, other things held
constant, means that a relatively small amount or percent of change and variable costs per unit is constant.
in sales will result in (amount or percentage) in operating income.
Plan B seems better than Plan A at the point of profit maximizing
Note that all discussions here are considered a relatively large output. Notice that the maximum output of P148 for Plan B is higher
change EBIT earnings before interest and taxes (EBIT). than the P120 of Plan A. That in Plan B, P148 profit is at 150,000 units
sold while in Plan A it is P120. Further, the breakeven point of Plan A
Just like BEP, the effect in net income for any change in sales could be is only 50,000 units as compared to the 82,500 units of Plan B. Small
predetermined using the operating leverage factor. Knowing the businesses must recognize that successful products will attract
operating leverage factor (OLF) or the degree of operating leverage competition and survival requires that one has to expand rapidly to a
(DOL), the management could easily determine the resulting net size where they have low costs and be able to charge at low prices.
income given a desired percentage increase in sales. Thus, planning and the determination of breakeven point become
more and more complicated. But no matter how complicated it will
be, managers can prepare their plans better if they fully understand
OPERATING LEVERAGE FACTOR OR DOL the relationships of costs, volume and profit.
OLF = CM / NI
DOL = % CHANGE IN NI / % CHANGE IN SALES PLAN A
A B C D E F G H
unit price Total VC/U TVC TF Total Profits
% CHANGE IN NI = % CHANGE IN SALES X OLF s revenue (a
x b)
(a x d) C costs (e +
f)
(c – g)

BREAK-EVEN SALES REVENUE = FIXED 0 13.2 00.00 00.00 0.00 10 100 (100)
0 0
EXPENSES / CMR 25 10.0 250 10.00 250 10 350 (100)
0 0
50 9.00 450 7.00 350 10 450 0
0
75 8.00 600 5.33 400 10 500 100
Cost structure illustrative case 100 7.20 720 5.00 500
0
10 600 120
Company CM/NI OLF X %C %C NI 0
125 6.40 800 4.92 615 10 715 85
S 0
A 200,000 / = 4 X 40% 150 5.85 878 5.27 791 10
0
891 (13)

50,000 10% = 175 540 945 6.00 1,050 10 1,150 (205)

0
B 100,000 / = 2 X 20% 200 4.90 980 7.50 1,500 10 1,600 (620)
0
50,000 10% =
C 450,000 / = 9 X 90% PLAN B
50,000 10% = A B C D E F G H
unit price Total VC/U TVC TF Total Profits
s revenue (a (a x d) C costs (e + (c – g)
x b) f)
0 13.2 00.00 00.00 0.00 20 200 (200)
% CHANGE IN NI / % CHANGE IN SALES 25
0
10.0 250 12.00 300
0
20 500 (250)
A 40% / 10% = 4 X 40% 0 0
50 9.00 450 7.50 375 20 575 (125)
10% = 0
B 20% / 10% = 2 X 20% 75 8.00 600 5.73 430 20
0
630 (30)

10% = 100 7.20 720 4.60 460 20 660 60

0
C 90% / 10% = 9 X 90% 125 6.40 800 3.92 490 20 690 10
0
10% = 150 5.85 878 3.53 530 20 730 148
0
175 540 945 3.54 620 20 820 125
OPERATING LEVERAGE FACTOR 0
200 4.90 980 3.70 740 20 940 40
- is a measure, at a particular level of sales, of 0

percentage impact on net income of a given

percentage change in sales revenue.
PLAN B HIGH LEVERAGE GRAPH