Cost Volume Profit

Relationship
CVP analysis
 Show close relationship between the cost,
volume and profit.
 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?
contribution

 Contribution is the difference between sale

and variable cost.

 It may be define as the excess of selling price

over variable/marginal cost cost per unit.

 CONTRIBUTION= SALES – VARIABLE

COST(M.C)
 Basics of Cost-Volume-Profit
Analysis
Racing Bicycle Company
Contribution Income Statement
For the Month of June

Sales (500 bicycles) $ 250,000

Less: Variable expenses 150,000
Contribution margin 100,000
Less: Fixed expenses 80,000
Net operating income $ 20,000

Contribution Margin (CM) is the amount

remaining from sales revenue after variable
expenses have been deducted.
Profit volume ratio
 P/V Ratio= Contribution/ Sale * 100
 Contribution = sales – variable cost
 P/V Ratio establish relation between the

contribution and sale

 Higher the P/V Ratio more will be the profit
 Lower the p/v ratio lesser will be the profit
How P/V Ratio increased
 By increasing the contribution:
 Increasing the selling price
 Reducing the variable cost

Racing Bicycle Company Racing Bicycle Company

Contribution Income Statement Contribution Income Statement
For the Month of June For the Month of June

Sales (500 bicycles) $ 250,000 Sales (500 bicycles) $ 300,000

Less: Variable expenses 150,000 Less: Variable expenses 150,000
Contribution margin 100,000 Contribution margin 150,000
Less: Fixed expenses 80,000 Less: Fixed expenses 80,000
Net operating income $ 20,000 Net operating income $ 70,000
Break-Even point
 The point of sales volume at which total
revenue = total expenses
 It is the point of no profit no loss
 At this point contribution = fixed cost
 If production or sale is increased beyond this

level there shall be profit to the organisation.

 If decrease than loss to the organisation.
 Sales revenue= fixed cost + variable cost
Calculation of BEP

1) Algebraic formula method

2) Graphic or chart method

Algebraic formula method:
1. Break-Even point in units: fixed cost /
contribution

2. Break-Even point in money value: Fixed cost

/ contribution * sales
With the use of P.V Ratio: fixed cost / P.V ratio

3. Break-Even point as a %age: Fixed Cost /

Total contribution
contribution = sales - variable cost
Graphic method
The relationship among revenue, cost, profit
and volume can be expressed graphically by
preparing a CVP graph.
 contribution margin income statements

at 300, 400, and 500 units sold. We will use

this information to prepare the CVP graph.

Income Income Income

300 units 400 units 500 units
Sales $ 150,000 $ 200,000 $ 250,000
Less: variable expenses 90,000 120,000 150,000
Contribution margin $ 60,000 $ 80,000 $ 100,000
Less: fixed expenses 80,000 80,000 80,000
Net operating income $ (20,000) $ - $ 20,000
 CVP Graph
450,000

400,000

350,000

300,000

In
In aa CVP
CVP graph,
graph, unit
unit volume
volume is
Dollars

250,000
is
200,000 usually
usually represented
represented on on the
the
150,000 horizontal (X) axis and rupee on
horizontal (X) axis and rupee on
100,000
the
the vertical
vertical (Y)
(Y) axis.
axis.
50,000

-
- 100 200 300 400 500 600 700 800

Units
 CVP Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000 Fixed Expenses

100,000

50,000

-
- 100 200 300 400 500 600 700 800

Units
 CVP Graph
450,000

400,000

350,000

300,000
Dollars

250,000
Total Expenses
200,000

150,000 Fixed Expenses

100,000

50,000

-
- 100 200 300 400 500 600 700 800

Units
 CVP Graph
450,000

400,000

350,000 Total Sales

300,000
Dollars

250,000
Total Expenses
200,000

150,000 Fixed Expenses

100,000

50,000

-
- 100 200 300 400 500 600 700 800

Units
 CVP Graph

Break-even point
450,000

400,000 (400 units or Rs.200,000 in sales)

350,000
r e a
it A
of
Pr
300,000
Rupee

250,000

200,000

150,000

r e a
A
100,000

o s s
L
50,000

-
- 100 200 300 400 500 600 700 800

Units
The Margin of Safety
 The excess of actual or budgeted sale over the
break even sale is known as the margin of
safety.
 BEP is no profit no loss, sales beyond the BEP
represents margin of safety.
 The size of margin of safety is an important
indicator of the strength of a business.
 The larger margin of safety indicates that the
business is sound and
 Even if there is a substantial fall in sales, there
will still be some profit.
 Margin of safety = total sale - sales at BEP
 M.S Ratio = M.S/Sales *100

or
 Profit/P.V Ratio *100
 Sales revenue
Total Cost/Revenue $

Profit
Total cost

BEP Sales (units)

Margin of safety
 If we assume that RBC has actual sales of
$250,000, given that we have already
determined the break-even sales to be
$200,000, the margin of safety is $50,000 as
shown (Total sale - sale at BEP)

Break-even
sales Actual sales
400 units 500 units
Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net operating income $ - $ 20,000
 The margin of safety can be expressed as
20% of sales.
 M.S Ratio= M.S/Sales*100
 50000 ÷ 250000 * 100 = 20%
Margin of safety improved by:
 Reducing the fixed cost (Outsource Services, Don’t
Drain Cash for Your Equipment, Use Shared Office Space,
renegotiate a lease, Negotiate a reduction in pay levels. This
is what some businesses have done in the recession to avoid
redundancies.)
 Reducing variable cost
 Improve efficiency and productivity
 Increasing the level of production
 Increasing the selling price
Angle of incidence
 The angle of incidence is the angle between
the sales line and the total cost line formed at
the BEP, where the sales line and the cost line
intersect each other.
 It is the earning capacity of a business
 Larger the angle of incidences high rate of

profit.
 Sales revenue
Total Cost/Revenue $

c ide nce
g le of in Total cost
An

BEP Sales (units)

Margin of safety
Marginal costing
 In marginal costing only variable costs are
taken into the account for computing the cost
of product.
 Sales - marginal cost(v.c)= Contribution
 Marginal cost = sales - contribution
Advantage of marginal costing
 Helpful in decision making: make or buy, if
M.C of component is lower than the purchase
price than it should be manufacture own.
Ex: M.C /Unit = 60, Fixed cost/unit = 8
Purchase price = 62
 Determining the BEP (break even point)
 It help in cost control: by concentrating on

variable cost as the fixed cost is non-

controllable.
 Help in short term planning: S.T planning can
be done with the help of the BEP
 Helpful to apply other techniques of costing:

like standard costing and budgetary control

 Simple to operate and easy to understand:

fixed cost are kept outside, and prepared on

the basis of marginal cost.
 Help management in production planning:

Marginal cost (V.C) remain same per unit of

output irrespective of level of activity.
Limitations of marginal costing
 Price can not be fixed with the help of
marginal costing alone: fixed cost & variable
cost needed.
 Ignore time factor: one take more time to

manufacture than other then it take more

cost than other.
 Variable cost per unit does not constant:

price of raw material and labour. Hence cost

increase or decrease
 Technology development: with development
of technology fixed expenses have increased
and their impact on production is much more
than of variable expenses.
 Not better cost control: Cost control can be

better done by budgetary control and

standard costing because it does not provide
any standards for evaluation of performance.