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Math on CVP

The document discusses Credit Operations and Management (COM) with a focus on Cost-Volume-Profit (CVP) analysis and break-even point (BEP). It outlines the importance, assumptions, and limitations of break-even analysis, as well as the components and assumptions of CVP analysis. Additionally, it provides practical examples and calculations related to contribution margin, break-even sales, margin of safety, and operating leverage.

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38 views

Math on CVP

The document discusses Credit Operations and Management (COM) with a focus on Cost-Volume-Profit (CVP) analysis and break-even point (BEP). It outlines the importance, assumptions, and limitations of break-even analysis, as well as the components and assumptions of CVP analysis. Additionally, it provides practical examples and calculations related to contribution margin, break-even sales, margin of safety, and operating leverage.

Uploaded by

mizan3132
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Credit Operations and Management (COM)

CVP Analysis
Break-Even Point: The break-even point (BEP) is the point at which cost or expenses and revenue are
equal. This is the activity point at which neither profit is made nor loss is incurred.
Usefulness/Importance of Break-even analysis:
Break even analysis:
1. helps to examine loan proposal of a firm.
2. helps in assessing working capital requirement of a unit.
3. helps in revealing clear projections of profit planning of an enterprise at different production level.
4. helps to find rate of return on investment of capital at varying levels of production.
5. can be quite useful to management in determining the need for action.
Assumptions of Break-even point:
1. Fixed costs will tend to remain constant. In other words, there will not be any change in cost factor,
such as, change in property tax rate, insurance rate, salaries of staffs etc.
2. Price of variable cost factors, i.e., wage rates, price of materials, supplies, services etc.
3. Product specifications and methods of manufacturing and selling will not undergo a change;
4. Operating efficiency will not increase/decrease.
5. There will not be any change in pricing due to change in volume, competition etc.
Limitations of Break Even Analysis:
1. Breakeven analysis assumes that fixed costs, variable costs and sales revenue behave in a linear
manner. However, some overhead costs may be stepped in nature rather than remain constant. The
previously straight sales revenue line and total cost line tend to curve beyond a certain level of
production. As a result, a lower selling price is set to stimulate further sales and lower variable costs
can be obtained due to mass production.
2. It is assumed that all production is sold. The breakeven chart does not take the changes in stock
level into account.
3. Breakeven analysis can provide vital information for small and relatively simple companies that
produce large volume of the same product. It is not so useful for the companies producing multiple
products. Its applications tend to be limited especially in those jobbing companies where each item
produced is different..
Cost–volume–profit (CVP), in managerial economics, is a form of cost accounting. It is a simplified
model, useful for elementary instruction and for short-run decisions. CVP analysis expands the use of
information provided by breakeven analysis.
The assumptions underlying CVP analysis:
• The behavior of both costs and revenues is linear throughout the relevant range of activity.
• Costs can be classified accurately as either fixed or variable.
• Changes in activity are the only factors that affect costs.
• All units produced are sold (there is no ending finished goods inventory).
• When a company sells more than one type of product, the sales mix (the ratio of each product to total
sales) will remain constant.
The components of CVP analysis: Level or volume, Unit selling prices, Variable cost price, total fixed
costs.
Margin of Safety: Margin of safety represents the strength of the business. It enables a business to
know what the exact amount it has gained or lost is and whether they are over or below the break-even
point.
Margin of safety = (Current output - BEP)

Md. Mizanur Rahman, ACMA, CDCS, DAIBB, DIB; Contact: 01870478713 1


Credit Operations and Management (COM)
CVP Analysis
96th Banking Diploma
ABC Seating, a manufacturer of chairs, had the following information for 2020:
Sales 2,400 units
Sales price Tk. 40 per unit
Variable costs Tk. 15 per unit
Fixed costs Tk. 19,500
Calculate:
(i) What is the contribution margin ratio?
(ii) What is the break even point in sales?
(iii) What is the margin of safety in units and sales?
(iv) If the company wishes to increase its contribution margin by 40% in 2021, by how much will it
need to increase its sales, if all other factors remain constant?
Solution:
(i) Contribution margin ratio = = = = 0.625 = 6.25%
(ii) Break Even Point (Sales) = = = Tk. 31,200
(iii) Margin of Safety (unit) = Actual Sales – BEP Sales = 2,400 units – (Tk. 31,200 ÷ 40) = 2,400 units –
780 units = 1,620 units
Margin of safety (Taka) = (2,400 units × Tk.40) – Tk. 31,200 = 96,000 – 31,200 = Tk. 64,800
(iv) Contribution margin per unit = 40-15 = Tk. 25
Total Contribution margin = 2,400 units × Tk. 25 = Tk. 60,000
Contribution margin to be increased in 2021 = Tk. 60,000 × 40% = Tk. 24,000
Sales to be increased in 2021 (unit) = Tk.24,000 ÷ Tk. 25 per unit = 960 units
Sales to be increased in 2021 (Tk.) = 960 units × Tk.40 = 38,400
Question
The following is the Raiyan Corporation’s contribution format income statement for last month.
Tk.
Sales 12,00,000
Variable Costs 8,00,000
Contribution margin 4,00,000
Fixed Expenses 3,00,000
Net operating income 1,00,000
The company has no beginning or ending inventories and produced and sold 20,000 units during the
month.
Required:
(i) What is the company’s contribution margin ratio?
(ii) What is company’s “Break even units”?
(iii) If sales increase by 100 units by how much should net operating income increase?
(iv) How many units would the company have to sell to attain the target profits of Tk.1,25,000?
(v) What is the company’s margin of safety in Taka?
(vi) What is the company’s degree of operating leverage?
Solution:
(i) Contribution margin ratio = ×100 = × 100 = 33.33%

(ii) Break-even units = = = 15,000 units

Md. Mizanur Rahman, ACMA, CDCS, DAIBB, DIB; Contact: 01870478713 2


Credit Operations and Management (COM)
CVP Analysis
Here, Contribution margin per unit = Tk.4,00,000 ÷ 20,000 units = Tk.20
(iii) If sales increase by 100 units, the operating income will increase:
Contribution margin (20,100 × 20) 4,02,000
(-) Fixed expenses 3,00,000
Net Operating Income 1,02,000
(iv) Required Sales in Unit = = = 21,250 units
(v) Margin of safety = (Actual sales – Break even sales) × 60 = (20,000 – 15,000) × 60 = 5,000 × 60 =
Tk.3,00,000
Here Selling price per unit = Tk.12,00,000 ÷ 20,000 units = Tk.60 per unit
(v) Degree of operating leverage = = =4

Md. Mizanur Rahman, ACMA, CDCS, DAIBB, DIB; Contact: 01870478713 3

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