Cost-Volume-Profit Analysis

The managers of profit-seeking organizations usually study the effects of output volume
on revenue (sales), expenses (costs), and net income net profit. We call this study from
the study of cost-volume-profit (CPV) analysis.

Cost-volume-profit (CVP) analysis is the study of the effects of changes in costs and
volume on a company’s profits. CVP analysis is important in profit planning. It also is a
critical factor in such management decision as setting selling prices, determining
product mix and maximizing use of production facilities.

Assumptions of CVP Analysis

The following assumptions underlie each CVP analysis:-

• Fixed costs remain fixed even over a wide range of activity.

• The behavior of both costs and revenues is linear throughout the relevant range
of the activity index.

• All costs can analyze into their fixed and variable elements.

• Changes in activity are the only factors that affect costs.

• All units produced are selling out and selling price is same per unit.

• When more than one type of product is selling, the sales mix will remain
constant. That is, the percentage that each product represents of total sales will
stay the same. Sales mix complicates CVP analysis because different products
will have different products will have different cost relationships.
CVP analysis considers the interrelationships among the components:-

• Volume or level of activity

• Unit selling prices

• Variable cost per unit

• Total fixed costs

• Sales Mix

Contribution Margin

Contribution margin is the amount of revenue remaining after deducting variable costs.

Formula for contribution margin:

Sales – Variable Costs = Contribution margin.

Unit sales price $ 200

Unit variable cost $ 120

Unit contribution margin $ 80

Margin of Safety

The planned unit sells less the break-even unit sales. It shows how far sales can fall
below the planned level before losses occur.

Margin of safety = planned unit sales – break-even unit sales

Break-Even Analysis

The level of activity at which total revenues equal total costs (both fixed and variable) is
call break-even point. The process of finding the break-even point is call break-even
analysis.

Break-even Volume in units:

 Fixed Expenses

Unit contribution margin

Break-even volume in dollar:

Fixed expenses

Contribution margin ratio

Target net profit and an incremental approach:

Managers can also use CPV analysis to determine the total sales in units and dollars,
needed to reach a target profit.

Fixed expenses + Target net Income

Target sales in units=

Unit contribution margin

Miss Shagufta Islam is the manager of Asus’s new PDA Phone segments. She sells
PDA Phone and PDA Phone without camera. Annual fixed costs are 5 00,000. The
variable cost is $ 260 per PDA Phone and $120 per PDA Phone without camera set.
PDA Phone sells for $499 and PDA Phone without camera for $200 per set. Three-
PDA Phone without camera is produce for two PDA Phone.

• Contribution Margin for PDA Phone = Selling price – variable cost

= $499 – $260

= $ 239

• C. Margin for PDA Phone without camera = Selling price – variable cost

= $200 – $120

= $80

• Total contribution margin of PDA Phone and PDA Phone without camera.
 $ 239 X $ 3 = $717

$ 80 * $2 =$160

= $557

Break-even point in number of set (3 PDA Phone without camera 2 PDA Phone)

= fixed cost

Total contribution margin

= $500000

$ 557

= $ 898 set

Therefore,

$898 * $3 = $1794 number of PDA Phone at break-even point

 $898 * $2 = $1796 number of PDA Phone without camera at break-even point.

Income Statement:

Miss Shagufta Islam sale for the year was 3,000 PDA Phone and 2,300 PDA Phone
without camera.

MISS SHAGUFTA ISLAM’S

Income Statement

For the year ended in June 31, 2007

Sales (3000 PDA & 2,300 PDA without camera) $ 19, 57,000

Less: variable cost ($260 per PDA Phone & $ 9, 16,000

$ 120 per PDA Phone without camera)

Contribution Margin $ 10, 41,000

Less: Fixed costs $ 5, 00,000

Net Income $ 5, 41,000