COST-VOLUME-PROFIT (CVP)

ANALYSIS
COST-VOLUME-PROFIT (CVP)
ANALYSIS
• It is a managerial tool showing the relationship between various
ingredients of profit planning viz., cost, selling price and volume of
activity.
• As the name suggests, cost volume profit (CVP) analysis is the analysis
of three variables cost, volume and profit.
• Such an analysis explores the relationship between costs, revenue,
activity levels and the resulting profit.
• It aims at measuring variations in cost and volume.
 Assumptions

• Changes in the levels of revenues and costs arise only because of changes in the number of
product (or service) units produced and sold. The number of output units is the only revenue
driver and the only cost driver. Just as a cost driver is any factor that affects costs, a revenue
driver is a variable, such as volume, that causally affects revenues.
• Total costs can be separated into two components; a fixed component that does not vary with
output level and a variable component that changes with respect to output level. Furthermore,
variable costs include both direct variable costs and indirect variable costs of a product.
Similarly, fixed costs include both direct fixed costs and indirect fixed costs of a product.
• When represented graphically, the behaviours of total revenues and total costs are linear
(meaning they can be represented as a straight line) in relation to output level within a relevant
range (and time period).
• Selling price, variable cost per unit, and total fixed costs (within a relevant range and time
period) are known and constant.
• The analysis either covers a single product or assumes that the proportion of different products
when multiple products are sold will remain constant as the level of total units sold changes.
• All revenues and costs can be added, subtracted, and compared without taking into account
the time value of money.
Importance of CVP Analysis
• It provides the information about the following
matters:
• The behavior of cost in relation to volume.
• Volume of production or sales, where the business will
break-even.
• Sensitivity of profits due to variation in output.
• Amount of profit for a projected sales volume.
• Quantity of production and sales for a target profit level.
Impact of various changes on profit:
• An understanding of CVP analysis is extremely useful to
management in budgeting and profit planning. It elucidates
the impact of the following on the net profit:
• Changes in selling prices,
• Changes in volume of sales,
• Changes in variable cost,
• Changes in fixed cost.
 Contribution to Sales Ratio (Profit
Volume Ratio or P/V ratio)

A higher contribution to sales ratio implies that the rate of growth of

contribution is faster than that of sales. This is because, once the breakeven
point is reached, profits shall grow at a faster rate when compared to a
product with a lesser contribution to sales ratio.
Break-Even Analysis:
• Break-Even Analysis is also called Cost Volume Profit Analysis. The
term Break-Even Analysis is used to measure inter relationship
between costs, volume and profit at various level of activity.
• A concern is said to break-even when its total sales are equal to its
total costs. It is a point of no profit no loss.
• This is a point where contribution is equal to fixed cost.
• In other words, the break-even point where income is equal to
expenditure or total sales equal to total cost.
• In broad sense this technique is used to determine the possible
profit/loss at any given level of production or sales.
METHODS OF BREAK -EVEN
ANALYSIS
• Algebraic computations

• Graphic presentations
Breakeven Point (BEP)
Break-Even Point in Sales Volume
Question 4
• From the following particulars find out break-even point:
• Fixed Expenses Rs. 1.00.000
• Selling price Per unit Rs. 20
• Variable cost per unit Rs. 15

Break-Even Point in Units = Fixed Cost/Contribution per unit

Contribution per unit = Selling Price per unit - Variable Cost per unit

BEP Units = 20000

BEP in Sales = 20000 x 20 = 4,00,000
Profit Volume Ratio (P/V Ratio)
• Profit Volume Ratio is also called as Contribution Sales Ratio (or)
Marginal Income Ratio (or) Variable Profit Ratio.
• It is used to measure the relationship of contribution, the relative
profitability of different products. processes or departments.
• When we find out the P/V Ratio, Break-Even Point can be calculated
by the following formula:
Question 5
• From the following information calculate :
• (I) P/V Ratio
• (2) Break-Even Point
• (3) If the selling price is reduced to Rs. 80, calculate New Break-Even
Point:
• Total sales = Rs. 5,00,000
• Selling price per unit = Rs. 100
• Variable cost per unit = Rs. 60
• Fixed cost = Rs. 1,20,000
Question 6
• Sales Rs. 2,00,000
• Profit Rs. 20,000
• Variable Cost 60% of sales
• You are required to calculate:
• P / V Ratio
• Fixed Cost
• Sales volume to earn a profit of Rs. 50,000

• P / V Ratio = 40%; Fixed Cost = Rs. 60000; Sales volume to earn a profit
of Rs. 50,000 = Rs. 275000.
Question 7
• From the following particulars, calculate :
• (a) P / V Ratio
• (b) Profit when sales are Rs. 40,000, and
• (c) New break-even point if selling price is reduced by 10%
• Fixed cost = Rs. 8,000
• Break-even point = Rs. 20,000
• Variable cost = Rs. 60 per unit

• (a) P / V Ratio = 40%; (b) Profit when sales are Rs. 40,000 = Rs. 8000; (c)
New break-even point if selling price is reduced by 10% = 24002
Question 8 (Caselet)
• MNP Ltd. produces a chocolate almond bar. Each bar sells for Rs. 20.
The variable cost for each bar (sugar, chocolate, almonds, wrapper,
labour) total Rs. 12.50. The total fixed cost are Rs. 30,00,000. During
the year, 10,00,000 bars were sold. The CEO of MNP Ltd. not fully
satisfied with the profit performance of chocolate bar, was
considering the following options to increase the profitability :
• (I) Increase advertising
• (II) Improve the quality of ingredients and, simultaneously, increase
the selling price
• (III) Increase the selling price
• (IV) Combination of three.
• (I) The sales manager is confident that an advertising campaign could
double sales volume. If the company CEO's goal is to increase this
year's profits by 50% over last year's, what is the maximum amount
that can be spent on advertising.
• (2) Assume that the company improves the quality of its ingredients,
thus increasing variable cost to Rs.15. Answer the following questions:
• (a) How much the selling price be increased to maintain the same break-even
point?
• (b) What will be the new price, if the company wants to increase the old
contribution margin ratio by 50%?
• (3) The company has decided to increase its selling price to Rs. 25.
The sales volume drops from 10,00,000 to 8,00,000 bars. Was the
decision to increase the price a good one? Compute the sales volume
that would be needed at the new price for the company to earn the
same profit at last year.
• (4) The sales manager is convinced that by improving the
quality of ingredients (increasing variable cost to Rs. 15) and
by advertising the improved quality (advertisement amount
would be increased by Rs. 50,00,000), sales volume could be
doubled. He has also indicated that a price increase would not
affect the ability to double sales volume as long as the price
increase is not more than 20% of the current selling price.
Compute the selling price that would be needed to achieve the
goal of increasing profits by 50%. Is the sales manager's plan
feasible? What selling price would you choose? Why?
(I) The sales manager is confident that an advertising campaign
could double sales volume. If the company CEO's goal is to
increase this year's profits by 50% over last year's, what is the
maximum amount that can be spent on advertising.
(2) Assume that the company improves the quality of its ingredients, thus increasing
variable cost to Rs.15. Answer the following questions:
(a) How much the selling price be increased to maintain the same break-even point?
(b) What will be the new price, if the company wants to increase the old contribution
margin ratio by 50%?
(3) The company has decided to increase its selling price to Rs. 25. The sales
volume drops from 10,00,000 to 8,00,000 bars. Was the decision to increase
the price a good one? Compute the sales volume that would be needed at
the new price for the company to earn the same profit at last year.
(4) The sales manager is convinced that by improving the quality of ingredients (increasing variable
cost to Rs. 15) and by advertising the improved quality (advertisement amount would be increased
by Rs. 50,00,000), sales volume could be doubled. He has also indicated that a price increase would
not affect the ability to double sales volume as long as the price increase is not more than 20% of the
current selling price. Compute the selling price that would be needed to achieve the goal of
increasing profits by 50%. Is the sales manager's plan feasible? What selling price would you choose?
Why?
Question 9
• A Company manufactures a single product with a capacity of 1,50,000 units per
annum. The summarized profitability statement for the year is as under:

• Sales: 1,00,000 units @ RS.15 per unit 15,00,000

• Less : Cost of Sales :
• Direct Materials 300000
• Direct Labour 200000
• Production overhead :
• Variable 60000
• Fixed 300000
• Administration Overhead (Fixed) 150000
• Selling and Distribution Overheads:
• Variable 90000
• Fixed 150000 1250000
• Profit 250000
• You are required to evaluate the following options:
• (I) What will be the amount of sales required to earn a target profit of 25%
on sales, if the packing is improved at a cost of Re.1 per unit?
• (2) There is an offer from a large retailer for purchasing 30,000 units per
annum, subject to providing a packing with a different brand name at a cost
of Rs. 2 per unit. However, in this case there will be no selling and
distribution expenses. Also this will not, in any way, affect the company's
existing business. What be the break-even price for this additional offer.?
• (3) If an expenditure of Rs. 3,00,000 is made on advertising the sales would
increase from the present level of 1,00,000 units to 1,20,000 units at a
price of Rs. 18 per unit, will that expenditure be justified?
• (4) If the selling price is reduced by Rs. 2 per unit, there will be 100%
capacity utilization. Will the reduction in selling price be justified?
Margin of Safety
• The term Margin of safety refers to the excess of actual sales over the
break-even sales. It is known as the Margin of Safety. Margin of safety
can also be expressed as a percentage of sales.
• Margin of safety can be improved by :
• (a) Increasing the selling price
• (b) Reducing the variable cost
• (c) Selecting a product mix of larger PN ratio items
• (d) Reducing fixed costs
• (e) Increasing the output
• Margin of Safety = Total Sales - Break-Even Sales
As percentage;
Question 10
• From the following particulars, calculate Margin of safety :
• Fixed cost Rs. 1,00,000
• Variable cost Rs. 1,50,000
• Total Sales Rs. 3,00,000
Question 11 (Home Work)
• A company manufactures a product, currently utilizing 80% capacity with a turnover of
Rs. 8,00,000 at Rs.25 per unit. The cost data are as under:
• Material Cost Rs. 7.50 per unit; Labour Cost Rs. 6.25 per unit; Semi-Variable Cost
(including variable cost of Rs. 3.75 per unit) Rs. 1,80,000.
• Fixed Cost Rs. 90,000 upto 80% level of output, beyond this an additional Rs. 20,000 will
be incurred.
• Calculate:
• (1) Activity level at Break-Even Point.
• (2) Number of units to be sold to earn a net income of 8% of sales.
• (3) Activity level needed to earn a profit of Rs. 95,000.
• (4) What should be the selling price per unit, if break-even point is to be brought down
to 40% activity level?
Break-Even Chart
• A break-even chart is a graphical presentation which indicates the
relationship between cost, sales and profit.
• The chart depicts fixed costs, variable cost, break-even point, profit or
loss, margin of safety and the angle of incidence.
• Such a chart not only indicates break-even point but also shows the
estimated cost and estimated profit or loss at various level of activity.
• Break-even point is an important stage in the break-even chart which
represents no profit no loss.
• From the break-even chart, we can understand the following points :
• (1) Cost and sales revenue are represented on vertical axis, i.e., Y-axis.
• (2) Volume of production or output in units are plotted on horizontal axis, i.e., X-axis.
• (3) Fixed cost line is drawn parallel to X-axis.
• (4) Variable costs are drawn above the fixed cost line at different level of activity. The variable
cost line is joined to fixed cost line at zero level of activity.
• (5) The sales line is plotted from the zero level, it represents sales revenue.
• (6) The point of intersection of total cost line and sales line is called the break-even point which
means no profit no loss.
• (7) The margin of safety is the distance between the break-even point and total output
produced.
• (8) The area below the break-even point represents the loss area as the total sales and less than
the total cost.
• (9) The area above the break-even point represents profit area as the total sales more than the
cost.
• (10) The sales line intersects the total cost line represents the angle of incidence. The large angle
 Selling
Price/Unit VC per Unit CPU 10
25 15
Production Total Sales Fixed Variable Total Margin of
S.No Units Revenue Cost Cost Cost Profit/Loss Safety

1 12000 300000 2,50,000 180000 4,30,000 -1,30,000

2 15000 375000 2,50,000 225000 4,75,000 -1,00,000

3 20000 500000 2,50,000 300000 5,50,000 -50,000

4 25000 625000 2,50,000 375000 6,25,000 0 0

5 30000 750000 2,50,000 450000 7,00,000 50,000 5000

6 40000 1000000 2,50,000 600000 8,50,000 1,50,000 15000

 Relationship between Angle of
Incidence, Break-Even Sales and
Margin of Safety Sales
• (1) When the Break-even sales are very low, with large angle of incidence, it
indicates that the firm is enjoying business stability and in that case margin
of safety sales will also be high.
• (2) When the break-even sales are low, but not very low with moderate
angle of incidence, in that case though the business is stable, the profit
earning rate is not very high as in the earlier case.
• (3) Contrary to the above when the break-even sales are high, the angle of
incidence will be narrow with much lower margin of safety sales.
Thank You…!!