Cost volume profit

analysis

F. M. Kapepiso
Learning objectives
At the end of the lecture, you should be able to:
 Discuss the purpose and usefulness of CVP analysis
 Apply CVP techniques in both single product and multiple
product contexts
Introduction
 Cost volume profit (CVP) analysis is also known as break-even
analysis.
 This lesson explores how cost behavior, production levels and
sales volume impact an organization's profit.
 It is an important tool used to assist management in planning and
decision making.
 CVP looks specifically at the relationship between the following
five elements: product prices, product mix, variable cost per unit,
total fixed costs and the level of activity in order to improve
profitability.
 It aims to improve profitability by identifying the best combination
of the above five elements.
 It helps managers to answer some of the following questions:
◦ What if we increase our fixed costs and sales volume?
◦ What impact would this have on our contribution and net profit?
 CVP analysis is concerned with short term-decision making,
therefore it is useful to adopt the variable costing approach or
marginal costing.
 Marginal costing statement
 This format is useful to managers when making decisions
regarding changes to profits, costs and volume, since it
groups costs according to their behaviour.

Rand Totals
Sales XXXXXX
Less total variable costs XXXXXX

Contribution XXXXXX
Less total fixed costs XXXXXX

Net profit XXXXXX

 CVP- single product
Cost volume profit analysis is a technique used to determine the
effects of change in selling prices, costs and volume over profits.
There three methods that can be applied in CVP
 Using formulae
 Using algebraic equation
 Using graph
Contribution: known as contribution margin also, it is difference
between revenue and the variable cost of earning that revenue.
Contribution can be expressed on a $ per unit basis or percentage
(profit volume ratio/contribution margin ratio)
Formula:
S-V=C=F+P
(Selling price–Variable cost=Contribution=Fixed costs + Profits)

CMR = Contribution ×100

Sales
 CVP- single product…
Break – Even Point: A company breaks even for a period
when sales revenue is equal to total cost of that period or in
other words contribution equals the fixed costs. It can be
expressed in units or in dollar.

BEP (units) =Fixed cost TFC

Contribution per unit OR C

BEP (Dollars): = BEP (units) x selling price per unit

BEP (N$) = Total fixed cost = TFC

CMR CMR
 CVP- single product…
Required sales to earn desired net income/ target profit
1. Sales (units) = TFC + Desired profit
C per unit
2. Sales (value) = answer (a) x selling price per unit
OR
TFC + Desired profit
CMR
Remember that DP in above formula is profit before tax.

Therefore, if the target income is net of tax or after tax, the

same should be first converted into profit before tax by using
the following formula.

Profit before tax = Profit after tax / (1 – tax rate*)

* tax rate in decimal form
 CVP- single product…
Margin of safety indicates how close the business is operating
to the break even point or the extent to which the current or
expected level of sales can drop before a loss can be incurred.
Can be expressed in units, dollar or percentage.

MS (units) = Budgeted sales in units – break even sales in units

MS (dollar) = budgeted sales in dollar – break even sales in
dollar
MS (%) = budgeted sales units – break even sales units
budgeted sales units
Example 1-CVP analysis using formulae
Bellow is the marginal costing system of Kirsty Ltd which
manufacturers Uninterrupted Power Supplies (UPSs) for
desktop for the last month.
Rand totals Per unit Percentage
Sales (1650 power suplies) 825 000 ? 100%
Less: Variable costs 495 000 ? ?
Contribution 330 000 ? ?
Less: Fixed costs 130 000
Net profit 200 000

Note: Assume a tax rate of 30%.

Required: Calculate the following;
1. Contribution per unit and as a percentage
2. Breakeven point (in units and N$)
3. Sales in units and N$ assuming that the company would like to make a target profit of
N$250 000 before tax
4. N$ sales and sales in units, assuming that the company would like to make a target
profit of N$175 000 after tax
5. Margin of safety (expressed in units, N$ totals and as a percentage)
 Exercise 1

1.1. Use the following information and formulate four formulae which can be used in the
calculation of cost volume profit analysis. (8 marks)
Contribution / sales ratio Net profit Variable costs
Fixed costs Sales Contribution per unit

1.2. Consider the following: variable costs amount to $24, sales price is $30 and fixed costs per
annum are $68,000. The company wishes to make a profit of $16,000 per annum. Calculate
the required sales to achieve this profit (both in dollar and in units) (7 marks)
 CVP- single product…
Homework
A summary of a manufacturing organization’s budgeted profit
statement for its next financial year, when it expects to be
operating at 75% of capacity, is given bellow.
Sales 9000 units at $32 288 000,00
Less: Direct materials 54 000,00
Direct wages 72 000,00
Production overheads:Fixed 42 000,00
Variable 18 000,00
186 000,00
Gross profit 102 000,00
Less: Admin, selling and distribution costs:
Fixed 36 000,00
Varying with sales volume 27 000,00
63 000,00
Net profit 39 000,00
 Cost volume profit analysis…
Homework…

Required:
(a)(i) Calculate the break even point in units and in value.
(ii) Calculate the profit that could be expected if the company
operated at full capacity.
(b)If has been estimated that:
I. If the selling price per unit were reduced to $28, the increased
demand would utilize 90% of the company’s capacity without any
additional expenditure and
II. To attract sufficient demand to utilize full capacity would require
a 15% reduction in the current selling price and a $5,000 special
advertising campaign.
Present a statement showing the effect of the two alternatives and
compare with the original budget. Advice management which plan
should be adopted
 CVP analysis-Multi product
 Organizations typically produce and sell a variety of products
and services. To perform CVP analysis in a multi-product
organization, a constant product sales mix must be assumed.
In other words, we have to assume that when ever X units
of product A are sold, Y units of product B and Z units of
product C are also sold.
 Sales mix is how much of each of the products are sold in
proportion to total sales. It can be expressed as a ratio, e.g.
2:2:1 or as a percentage, e.g. 40%, 40%, and 20%.
 Consequently managers strive to sell a combination of
products that will maximise profits. Changes in the sales
mix cause profits to change.
CVP analysis-Multi product…
Example 2
Kirsty Ltd currently manufactures and sells UPSs (Uninterrupted Power
Supplies) for desktop computers. Due to the current electricity shortages,
power cuts have resulted in many companies losing valuable data. After
extensive market research, the company has decided to extend its product
range to include UPSs for data centres as well. These UPSs are emergency
power generators that are instantaneous or near instantaneous allowing
time for equipment to shut down properly and therefore ensure that
valuable data is not lost.
Currently fixed costs are N$130 000. With the production of the UPSs for the
data centre, the fixed costs would increase by a further N$260 000. This
includes additional supervisory salaries, additional equipment leased, etc.

The marginal costing income statements for June is on the next page.
 Marginal costing income statements for June
UPS for UPS for data centres Total
desktop computers 3 850 units 5 500 units
1650 units
R per Rand % R per Rand % Rand %
unit totals unit totals
Sales 500 825 000 100% 1 250 4 812 100% 5 637 500 100
Less: Total variable 300 495 000 60% 625 500 50% 2 901 250 %
costs 2 406 ?%
250
Contribution 200 330 000 40% 625 2 406 50% 2 736 250 ?%
Less: Total fixed 250 390 000
costs
Net profit 2 346 250
Required: Calculate the following:
1. Weighted average contribution per unit
2. Breakeven point in units
3. Weighted average contribution margin ratio
4. Breakeven point in N$
5. Sales in N$ assuming that the company would like to make a profit of N$3 000 000 before
tax
 CVP analysis-Multi product
Example 3
Suppose that PL produces and sell two products (M and N).
The M sells for $7 per unit and has a total variable cost of
$2.94 per unit, while the N sells for $15 and has a total
variable cost of $4.50 per unit. The marketing department has
estimated that for every five units of M sold, one unit of N will
be sold. The organization’s fixed cost total $36,000 and
budgeted sales revenue for next period is $74,000 in the
standard mix.
Required: calculate
 BEP using average contribution to sales ratio and BEP in
units
 Target profit and margin of safety
 Cost volume profit analysis…
Assumptions of CVP analysis

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

of products
•Break even chart may be time consuming
•Selling price, variable cost per unit and total fixed cost remain
unaffected by increase or decrease in sales volume.
•Firm is able to sell more units without affecting the cost
structure.
•In multi product situations, product mix is known in advance
and remains constant.
•Costs can be accurately classified in to fixed and variable
categories.
 Practice question 1
A computer software company develops and sells three
computer games, Gino, Dust and Elton. The combined sales of
all the products in 2007 was 9000 units and total fixed costs
amounted to $726 000. other relevant data for 2007 were as
follows: Gino Dust Elton
Sales price $600 $500 $450
P/V ratio 20% 30% 40%
Sales mix 5 1 4
Management expects sales in the current year to remain at
9000 total units and there is no intention to change the selling
price or cost structure. However, by reducing marketing
expenditure on Gino and spending more on Dust and Elton,
the marketing director believes that the sales mix can be
changed to 2:3:5
Required:
For the organization as a whole, calculate the P/V ratio, break even
in sales and profit of each sales mix respectively, and advice
management whether the proposed sales mix should be
implemented or not
Thanks