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Cost Volume Profit Analysis Notes

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17 views2 pages

Cost Volume Profit Analysis Notes

Uploaded by

ranamuhammadwasiflatif
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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MA2 Managing Costs & Finance

Cost Volume Profit Analysis

1 Cost volume profit Analysis is the study of the interrelationships between costs, volume and
profit at various activity levels.

Some basic definitions


Marginal cost (MC) the additional cost caused when one more unit is made. Marginal cost will be the
sum of all variable production costs per unit.

Total absorption cost (TAC) the total cost of manufacturing a unit. This is the sum of the marginal cost
and a fair share of the fixed production costs.

Fixed overhead absorption rate budgeted fixed production costs divided by budgeted output in units.

Profit per unit selling price per unit less total absorption cost per unit ie less marginal costs and
production fixed production costs.

Contribution per unit selling price per unit less all variable cost per unit

Contribution to sales ratio or C/S ratio The C/S ratio is a measure of how much contribution is earned
from each $1 of sales

2 Breakeven Analysis
Breakeven is the volume of sales at which the business makes neither a loss nor a profit. At breakeven
point, total cost equal to total revenue.

Breakeven point shows the minimum volume of sales which must be achieved to avoid making a loss in
the period.

At breakeven point total contribution is just large enough to cover total fixed cost or we can say that at
breakeven point, total contribution equal to total fixed cost.

3 Margin of Safety
The margin of safety is the difference in units between the expected/actual sales volume and the
breakeven sales volume and it is sometimes expressed as a percentage of the expected sales volume.

The margin of safety may also be expressed as the difference between the expected/actual sales revenue
and breakeven sales revenue, expressed as a percentage of the expected/actual sales revenue.

Compiled by: Muzzammil Malik Page 1


MA2 Managing Costs & Finance

3 Target Profit
In cost volume profit analysis we can also calculate the volume of sales that would be required to earn a
target level of profit. To achieve a target profit, the business will have to earn enough contribution to
cover all of its fixed cost then makes the required amount of profit.

4 Breakeven Charts & Profit Volume Chart


The breakeven point can also be determined graphically using a traditional breakeven chart or a
contribution breakeven chart.

The profit/volume (PV) chart is a variation of the breakeven chart which demonstrates the relationship of
profits to sales.

5 Limitations of Cost Volume Profit Analysis


Breakeven analysis is a useful technique for managers. Breakeven arithmetic can provide simple and
quick estimates. Breakeven charts provide a graphical representation of breakeven arithmetic.

Breakeven analysis has a number of limitations.

➢ It can only apply to a single product or a single mix of a group of products


➢ A breakeven chart may be time-consuming to prepare
➢ It assumes fixed costs are constant at all levels of output
➢ It assumes that variable costs are the same per unit at all levels of output
➢ It assumes that sales prices are constant at all levels of output
➢ It assumes production and sales are the same (inventory levels are ignored)
➢ It ignores the uncertainty in the estimates of fixed costs and variable cost per unit

Compiled by: Muzzammil Malik Page 2

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