COST-VOLUME-PROFIT (CVP) ANALYSIS

COST-VOLUME-PROFIT (CVP) ANALYSIS

CVP analysis examines the interaction of a firm’s sales

volume, selling price, cost structure, and profitability i.e.
it looks at the relationship between selling prices, sales
volumes, costs, and profits.
 COST-VOLUME-PROFIT (CVP) ANALYSIS

• CVP analysis in narrow sense: level of activity

when total cost = total sales value i.e. (Break
even Point). It helps in locating the level of
output which evenly breaks the cost and the
revenues.
• CVP analysis in broader sense: it refers to the
system of analysis which determine profit, cost
and sales value at different levels of output.
 COST-VOLUME-PROFIT (CVP) ANALYSIS
It is a powerful tool in making managerial decisions
including marketing, production, investment, and
financing decisions.
• How many units of its products must a firm sell to
break even?
• How many units of its products must a firm sell to
earn a certain amount of profit?
• Should a firm invest in highly automated machinery
and reduce its labor force?
• Should a firm advertise more to improve its sales?
 Assumptions of CVP Analysis

 
• Costs can be categorized as fixed, variable, or semi-variable.
Total fixed costs remain constant as activity changes.

• Variable costs per unit do not change over the relevant range.

• In manufacturing firms, inventories do not change (units

produced = units sold).

• The behavior of total revenue is linear (straight line). This

implies that the price of the product or service will not change
as sales volume varies within the relevant range.
 Assumptions of CVP Analysis

• The behavior of costs is linear (straight line)

over the relevant range.
• Selling price is constant throughout the entire
relevant range.
• Volume is the only cost driver. The relevant
range of volume is specified.
• In multi-product organizations, the sales mix
remains constant over the relevant range.
 CVP Analysis Advantages
• Assists in establishing pricing policies.
• Assists in analyzing the impact that volume has on
short-term profits.
• Assists in focusing on the impact that changes in
costs (variable and fixed) have on profits.
• Assists in analyzing how the mix of products affects
profits.
• Useful in setting up of flexible budget which indicate
cost at various levels of activities.
• Helps in taking number of managerial decisions.
• Helps to attain the targeted profit.
 Elements of CVP Analysis
• Marginal Cost Equation.
• Contribution Margin.
• P/V Ratio.
• Breakeven Point.
• Margin of Safety.
 Marginal Cost Equation.

Net Income (NI) = Total Revenue – Total Cost

Total Revenue = Selling Price Per Unit (P) * Number of Units Sold
(X)
Total Cost = Total Variable Cost (TVC) + Total Fixed Cost (TFC)

Total Variable Cost = Variable Cost Per Unit (V) * Number of Units
Sold (X)

NI = P X – V X – F Marginal Cost Equation

NI = X (P – V) – F Sales Revenue (P X)
- Variable Costs (V X)
Contribution Margin
- Fixed Costs (F)
Net Income (P)
 Contribution Margin.
• Contribution margin is equal to the difference
between total revenue and total variable costs
• It is a difference between the sales and the
marginal cost of sales.
• It contributes towards profit after meeting fixed
cost.
• Contribution helps to find out the profitability of
the product, department, product mix, and helps
to maximize the profit.
 Contribution Margin.
Contribution margin per unit = Selling price/unit -
Variable cost/unit
Total for
Per Unit 2 units %

Revenue 200 400 100%

Variable costs120 240 60%
Contribution margin 80 160 40%

Contribution - Fixed Expenses = Profit/Loss

Contribution = Fixed Expenses (+/-) Profit/Loss
 Contribution Margin Income Statement
• Income statement that highlight the contribution margin

Packages Sold
0 1 2 25 40
Revenue 0 200 400 5,000 8,000
Variable costs 0 120 240 3,000 4,800
Contribution margin 0 80 160 2,000 3,200
Fixed costs 2,000 2,000 2,000 2,000 2,000
Operating income (2,000) (1,920) (1,840) 0 1,200
 Cost-Volume-Profit Graph
Breakeven Total revenues
10,000 line
Point
25 units
8,000 Total costs
line
6,000
Operating
4,000 income

2,000
Operating
0 loss

0 10 20 30 40 50
Units Sold
 P/V Ratio
• P/V Ratio is important for studying the profitability
of operations of a business.
• This ratio establishes the relationship between
contribution and sales value.
• The term P represents Profit that is equivalent to
contribution. The term V refers to Volume of sales.

Contribution ratio = Contribution per unit

or PV Ratio Selling price per unit
 P/V Ratio
Alternatively,
• P/V Ratio = C x 100
s

• P/V Ratio = Sales-Variable Cost x 100

Sales
• P/V Ratio = Change in profit or Contribution x 100
Change in sales
 Importance of P/V Ratio:
• Management can know which product is more profitable.
• Management can reward the department, which is working
efficiently and pull up that one, that is not working to the
level expected.
• Higher the P/V Ratio, more will be the profit.
• Increase in P/V ratio without increase in fixed cost result in
higher profit.
• Thus, aim of management is at increasing the P/V Ratio,
identifying where the action is needed. P/V Ratio indicates
availability of margin on sales made. So, firm that enjoys
higher P/V Ratio stands to gain, when demand for the product
is growing
 Use of CVP Analysis
• CVP analysis can determine, both in units and sales
in Rupees:
• the volume required to achieve target profit levels
• the effects of discretionary expenditures
• the selling price or costs required to achieve
target volume levels
• the volume required to be break even
• CVP analysis helps analyze the sensitivity of profits
to changes in selling prices, costs, volume and
sales mix.
 Break Even Analysis
• Break-even analysis establishes the relationship
between revenues and costs with respect to volume.
• It indicates the level of sales at which total costs are
equal to total revenues.
• Many a time, CVP analysis is popularly designated as
break-even analysis. But, there is a narrow
difference between the two. CVP analysis is
concerned with the entire profit planning, while the
breakeven analysis is one of the techniques used in
that process.
 Break-Even Point:
• Break-even point is the point at which the firm makes no
profit or loss.
• At the break-even point, the firm is in the stage of
equilibrium.
• The equilibrium point is commonly known as break-even
point.
• Break-even point is that point, where the revenue is just equal
to total costs.
• This is a zero position. After this level, if the firm makes
production and sells above the variable cost, it earns profit. If
the sales fall below this level, firm sustains loss.
 Assumptions of Break-Even Analysis
1. Costs segregation: It is based on the
assumption that all costs can be segregated
into fixed costs and variable costs.
2. Constant Selling Price: The selling price
remains constant. That is, selling price does
not change with volume or other factors.
3. Constant Fixed costs: Fixed costs are constant,
at all levels of activity. They do not change,
with change in sales.
 Assumptions Break-Even Analysis
4. Constant Variable costs: Variable cost per unit is
constant. So, variable costs fluctuate, directly, in
proportion to changes in volume of output. In other
words, they change in direct proportion to sales volume.
5. Synchronized production and sales: It is assumed
production and sales are synchronized. That is,
inventories remain the same in the opening stock and
closing stock.
6. Constant sales mix: In case, more than one product is
manufactured, sales mix of products sold does not
change.
 The break-even analysis is based on the
following assumptions:
7. No Change in operating efficiency: There is no
change in operating efficiency.
8. No other factors: The volume of output or
production is the only factor that influences
the cost. No other factors have any influence
on break-even analysis.
 CVP = Break Even Chart
Traditional Format

Total
Revenue

Total Rs.
Total Costs
Breakeven
Point

Angle of
incidence

Total Variable
Costs

Total Fixed
Costs

Level of Activity
 Affect on BEP as per Cost Structures

Alternative rental arrangements

Option 1 Option 2 Option 3

2,000 Fixed Fee 1,400 Fixed Fee 20% Commission
+ 5% Commission
Rev Rev
Rev
Cost Cost
Cost

Units Units Units

Breakeven = 25 units Breakeven = 20 units Breakeven = 0 units
Calculation of Breakeven Point

BEP in units = F
S – V/Unit*

* = Contribution Margin Per Unit

F
BEP in sales =
CMR or P/V Ratio
 Cash Break Even Point
• Many a time, it is difficult for the industrial units to
become break-even in the initial years. From that
environment, the concept of cash-break even
point has emerged.
• The Cash break-even point may be defined as that
point of sales volume, where cash revenues are
equal to cash costs. In other words, if we eliminate
non-cash items from revenues and costs, the
breakeven analysis on cash basis can be computed.
 Cash Breakeven Point
• Depreciation is, generally, a fixed cost. However, when
plant and machinery is used for additional shifts, the
additional depreciation is a variable cost.
• Reason for treating the additional depreciation as variable
cost is the firm can avoid additional shift, at any time, and
in such circumstances this cost would not be incurred.
• To calculate cash break even point, depreciation is to be
removed from fixed costs. Additional depreciation,
component, treated as variable cost, is also to be excluded
from variable costs. Similarly, deferred expenses are to be
excluded from the fixed cost
 Cash Break Even Point

• Cash Break-Even Point (in terms of units) =

Cash Fixed Cost

Cash Contribution per unit
 Margin of Safety.

• The Margin of Safety is the difference

between the expected level of sales and
break-even sales. It may be expressed in units
or Rupees of sales.
 Calculation of MOS
• MOS = Actual Sales – BEP Sales.

• MOS = Profit
P.V.R
 Practice Questions
 The following is the statement of cost and sales of
Sharma & Bros :
Rs.
• Fixed Cost 1,80,000
• Variable Cost 2,80,000
• Net Sales 4,20,000
Determine how much sales volume is to be
increased in order for the company to break-even.
 Practice Questions
Ashok & Co. Ltd. gives you the following information:
Sales Profit
Rs. Rs.
Period-1 15,000 400
Period-2 19,000 1,150
Calculate:
(a) The PV Ratio
(b) The Profit when sales are Rs.12,000
(c) The break-even-point.
(d) The sales required to be made to earn a profit
of Rs.2000.
 Practice Questions
 From the following data calculate:
(1) Break-even point expressed in amount of sales in
rupees
(2) Number of units that must be sold to earn a profit of
Rs.60,000 per year.
Rs.
Sales price 20 per unit
Variable Manufacturing Costs 11 per unit
Variable Selling costs 3 per unit
Fixed Factory Overhead 5,40,000 per unit
Fixed Selling Costs 2,52,000 per year
 Practice Questions
  A garment Shop sells dresses. The cost of each dress is comprised of
the following: Selling price of Rs. 1,000 and variable (flexible) costs of
Rs. 400. Total fixed (capacity-related) costs for Shop are Rs. 90,000.
 
What is the contribution margin per dress?
  
What is the Shop’s total profit when 200 dresses are sold?
  
How many dresses must Shop sell to reach the breakeven point?
  
How many dresses must Shop sell to yield a profit of Rs.60,000?
 
 
 Practice Questions
Northens cold Company sells several products. Information of average revenue and
costs are as follows:
  Rs.
Selling price per unit 20.00
Variable costs per unit:
Direct materials 4.00
Direct manufacturing labor 1.60
Manufacturing overhead 0.40
Selling costs 2.00
Annual fixed costs 96,000
 
• Calculate the contribution margin per unit.  
• Calculate the number of units Northens cold’s must sell each year to break even.
• Calculate the number of units Northens cold’s must sell to yield a profit of Rs.
144,000.
 
 Practice Questions
• Markwell Ltd. manufactures filing cabinets. For the current
year, the company expects to sell 4,000 cabinets involving
a loss of Rs. 2,00,000. Only 40% of the plant normal
capacity is being utilized during the current year. The fixed
costs for the year are Rs. 10,00,000 and fully variable costs
are 60% of the sales value. You are required to:
(i) Calculate the break-even point, (ii) Calculate the profit if
the company operates at 70% of its normal capacity, (iii)
Calculate the sales required to achieve a profit of Rs.
60,00,000. (iv) Calculate the revised break-even point if
the existing selling prices are decreased by 10%, the total
fixed and variable expenses remaining the same.
 Practice Questions
• The Taylor Company produces two products, A and B. Expected data
for the first year of operation is:
A B
• Expected Sales (units) 8,000 12,000
• Selling price Rs. 45 Rs. 55
• Variable cost 30 35
• Total fixed costs are expected to be Rs. 3, 60,000 for the year.
You are required to answer the followings:
(i) if sales prices and costs are as expected, what will be the
operating income and the break-even point volume in sales revenue?
(ii) Assume that prices and costs were as expected, but Taylor sold
12,000 units of A and 8,000 units of B. recalculate the operating
income and the break-even point volume in sales revenue?
 Practice Questions
• The price structure of a cycle made by the cycle company Ltd. is
as follows:
Per cycles
Material Rs.60, labour Rs.20, variable overhead Rs.20, fixed
overhead Rs.50, profit Rs.50, and selling price Rs.200
This is based on the manufacture of 1 lakh cycles per annum.
The company expects that due to competition, they will have to
reduce selling price but, and they want to keep the total profits
intact. What level of production will have to reach?
I.e. how many cycles will have to be made to get the same
amount of profits, if:
(A) The selling price is reduced by 10%
(B) The selling price is reduced by 20%
 Practice Questions
The fixed cost for the year are Rs 40000 the variable cost per
unit for a single being made is Rs2.Each unit sells at Rs 10.
You are required to calculate :
• BEP
• It has been found that Rs 80000 will be the likely sales
turnover for the next budget period .The cost and the selling
price remain the same, calculate the estimated contribution
and profit
• The profit target of Rs 30000 has been budgeted. Calculate
the turnover required