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CVP Analysis

The document discusses cost-volume-profit (CVP) analysis, which is a five-step decision making process used in planning and control. It assumes costs and revenues change linearly with volume and are known constants. The key formulas discussed are contribution margin, breakeven point, profit planning, sensitivity analysis, margin of safety, and operating leverage. It also addresses extensions for income taxes and analyzing multiple products.

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Saurabh Singh
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© © All Rights Reserved
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Download as PPT, PDF, TXT or read online on Scribd
42 views

CVP Analysis

The document discusses cost-volume-profit (CVP) analysis, which is a five-step decision making process used in planning and control. It assumes costs and revenues change linearly with volume and are known constants. The key formulas discussed are contribution margin, breakeven point, profit planning, sensitivity analysis, margin of safety, and operating leverage. It also addresses extensions for income taxes and analyzing multiple products.

Uploaded by

Saurabh Singh
Copyright
© © All Rights Reserved
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Cost-Volume-Profit Analysis

A Five-Step Decision Making


Process in Planning & Control Revisited
1. Identify the problem and uncertainties
2. Obtain information
3. Make predictions about the future
4. Make decisions by choosing between
alternatives, using Cost-Volume-Profit (CVP)
analysis
5. Implement the decision, evaluate
performance, and learn
Foundational Assumptions
in CVP
• Changes in production/sales volume are the sole cause
for cost and revenue changes
• Total costs consist of fixed costs and variable costs
• Revenue and costs behave and can be graphed as a linear
function (a straight line)
• Selling price, variable cost per unit and fixed costs are all
known and constant
• In many cases only a single product will be analyzed. If
multiple products are studied, their relative sales
proportions are known and constant
• The time value of money (interest) is ignored
Basic Formulae
CVP: Contribution Margin
• Manipulation of the basic equations yields an
extremely important and powerful tool extensively
used in Cost Accounting: the Contribution Margin
• Contribution Margin equals sales less variable costs
– CM = S – VC
• Contribution Margin per Unit equals unit selling
price less variable cost per unit
– CMu = SP – VCu
Contribution Margin,
continued
• Contribution Margin also equals contribution
margin per unit multiplied by the number of
units sold (Q)
– CM = CMu x Q
• Contribution Margin Ratio (percentage) equals
contribution margin per unit divided by Selling
Price -CMR = CMu ÷ SP
– Interpretation: how many cents out of every sales
dollar are represented by Contribution Margin
Basic Formula Derivations
• The Basic Formula may be further rearranged
and decomposed as follows:
Sales – VC – FC = Operating Income (OI)
(SP x Q) – (VCu x Q) – FC = OI
Q (SP – VCu) – FC = OI
Q (CMu) – FC = OI
• Remember this last equation, it will be used
again in a moment
Breakeven Point
• Recall the last equation in an earlier slide:
– Q (CMu) – FC = OI
• A simple manipulation of this formula, and
setting OI to zero will result in the Breakeven
Point (quantity): -BEQ = FC ÷ CMu
• At this point, a firm has no profit or loss at the
given sales level
• If per-unit values are not available, the
Breakeven Point may be restated in its alternate
format: BE Sales = FC ÷ CMR
Breakeven Point, extended:
Profit Planning
• With a simple adjustment, the Breakeven
Point formula can be modified to become a
Profit Planning tool.
– Profit is now reinstated to the BE formula,
changing it to a simple sales volume equation
– Q = (FC + OI)
CM
CVP: Graphically
Profit Planning, Illustrated
CVP and Income Taxes
• From time to time it is necessary to move back and
forth between pre-tax profit (OI) and after-tax profit
(NI), depending on the facts presented
• After-tax profit can be calculated by:
– OI x (1-Tax Rate) = NI
• NI can substitute into the profit planning equation
through this form:
– OI = I I NI I
(1-Tax Rate)
Sensitivity Analysis
• CVP Provides structure to answer a variety of
“what-if” scenarios
• “What” happens to profit “if”:
– Selling price changes
– Volume changes
– Cost structure changes
• Variable cost per unit changes
• Fixed cost changes
Margin of Safety
• One indicator of risk, the Margin of Safety
(MOS) measures the distance between
budgeted sales and breakeven sales:
– MOS = Budgeted Sales – BE Sales
• The MOS Ratio removes the firm’s size from
the output, and expresses itself in the form of
a percentage:
– MOS Ratio = MOS ÷ Budgeted Sales
Operating Leverage
• Operating Leverage (OL) is the effect that
fixed costs have on changes in operating
income as changes occur in units sold,
expressed as changes in contribution margin
– OL = Contribution Margin
Operating Income

• Notice these two items are identical, except


for fixed costs
Effects of Sales-Mix on
CVP
• The formulae presented to this point have assumed a
single product is produced and sold
• A more realistic scenario involves multiple products
sold, in different volumes, with different costs
• The same formulae are used, but instead use average
contribution margins for bundles of products.

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