Cost Volume Profit Analysis

By Ghanendra Fago For MBA, AIM

Cost-Volume-Profit Analysis
Study of relationship between costs, volume, and

profits.
If 10% volume changed, what is the expected

change in profit and cost?

If 10% cost changed,

If volume and cost changed, what is the expected

change in profit?
Break even analysis A techniques of CVP

analysis

By Ghanendra Fago (M. Phil, MBA) For AIM

Use of CVP Analysis

What level of sales is needed to avoid the losses? What sales volume is needed to earn a target profit? What would be the effect on profits if we reduce our selling

price and sell more units? What sales volume is required to meet the additional fixed charges arising from an advertising campaign? What will be the effect on the profit, where sales mix is changed? What will be the new-break-even point when there is change in prices, costs, volume, and sales mix? Which product or product mix is most profitable? Which product or product mix should be discontinued or not?
By Ghanendra Fago (M. Phil, MBA) For AIM
3

Assumptions of CVP Analysis i.e Certainty Analysis

Costs can be divided into fixed and variable elements

Fixed costs will remain constant

Variable cost per unit and selling price remain constant. A company produces a single product. If multiple

product mix remains constant.

Production equals to sales i.e. there is no change in

inventory.
No change in capacity and productivity.

By Ghanendra Fago (M. Phil, MBA) For AIM

Break Even analysis

Break-even analysis is a

technique of representing and studying the inter-relationship of the three basic components of CVP: cost, volume and profit. The break-even analysis determines a relationship between the revenues and costs with respect to volume. Break-even analysis is always taken as an important part of profit planning as it gives the planner many insights into the data with which he or she is working. It is a point where the profit is zero as the total revenues are equal to total costs. In other words, it is that level of activity (in units or in Rs.) at which revenue equals cost.
By Ghanendra Fago (M. Phil, MBA) For AIM
5

Methods of CVP Analysis

Graphic approach

Income statement Approach

Contribution margin or Formula approach Equation approach

By Ghanendra Fago (M. Phil, MBA) For AIM

Graphic Analysis of Break Even Point

Sales revenue 250 Profit Total cost

Cost, Price, 200 Profit (in 000 Rs.) 150

100 50 Loss

BE Point Variable Cost

Fixed Cost 50 100

200 250 Margin of safety Quantity in units (in 000 units)

7

150

By Ghanendra Fago (M. Phil, MBA) For AIM

Particulars

Income Statement Approach Amounts

Sales 10,000 units @ Rs10 per unit

Rs. 100,000 100%

Less: Variable cost @ Rs. 4 per unit

Contribution Margin @ Rs. 6 per unit Less: Fixed costs Net profit

40,000
60,000 50,000 10,000

40%
60%

By Ghanendra Fago (M. Phil, MBA) For AIM

Variable Income Statement

Sales in units Sales revenue @Rs 20 Less: variable cost @Rs 12 Contribution margin @Rs 8 Less: fixed cost Net income before tax 56,250 11,25,000 6,75,000 4,50,000 4,50,000 0

By Ghanendra Fago (M. Phil, MBA) For AIM

Contribution Margin Approach Or Formula Approach

The approach uses the concept of contribution

margin and contribution margin ratio.

To find out the number of units to be sold to break-

even, the fixed cost can be divided by contribution margin contributed by each unit sold.
Break Even Point (in units)

= Fixed cost/CMPU

= .. units

= Fixed cost/PV ratio

= .. in Rupees

By Ghanendra Fago (M. Phil, MBA) For AIM

10

Formulae of Cost Volume Profit Analysis

1. Contribution Margin per Unit (CMPU) = Selling Price per unit Variable cost per unit = Selling Price per unit x PV ratio = Difference in Profit/difference in sales units = Profit/margin of safety units 2. Profit Volume (Contribution margin) Ratio = 1 CV ratio or = 1- VCPU/SPPU = Difference in Profit/difference in sales revenues = 1- Difference in costs/ difference in sales = Profit/margin of safety rupees 3. Break Even Point (in units) = Fixed cost/CMPU = units = Fixed cost/PV ratio = .in 11 By Ghanendra Fago (M. Phil,Rupees MBA)
For AIM

4. Required sales to earn desired profit:

Target sales volume to earn profit before tax in rupees = FC+ before tax target profit/Contribution margin ratio Target sales volume to earn profit before tax in units = FC+ before tax target profit/Contribution margin per unit Target sales volume to earn after tax (in rupees) = FC+{(desired profit after tax) / (1-t)}/Contribution margin ratio

Target sales volume to earn after tax (in units = FC+{(desired profit after tax) / (1-t)}/Contribution margin per unit
By Ghanendra Fago (M. Phil, MBA) For AIM
12

5. Profit on Sales
= Sales Variable Cost Fixed Cost = (Sales Rs. P/V Ratio) Fixed Cost = (Sales Units CMPU) Fixed Cost = Margin of Safety CMPU

6. Margin of Safety
= Actual Sales Break Even Sales = Margin of Safety/Actual sales = Profit/CMPU or PV ratio

7. Sales to earn equal profit by two alternative

=Differences in fixed costs/difference in PV ratio or CMPU
By Ghanendra Fago (M. Phil, MBA) For AIM
13

Multi Products/Sales Mix

Overall BEP (in Rs.) =Total fixed costs/WAPV ratio =Rs. Overall BEP (Units) = Total fixed costs/WACMPU = Units
Calculation of weighted average CMPU Product X Y Sales units Sales Mix CMPU Contribution

Weighted Average CMPU

By Ghanendra Fago (M. Phil, MBA) For AIM

14

Weighed Average profit Volume Ratio PV ratio

Product X Y Sales In amount Sales Mix PV Ratio Contribution (PV ratio Sales Mix)

Weighted Average PV ratio

By Equation: Sales revenues = Fixed costs + variable costs + profit In units: x = FC + VC + Profit or, x = FC + VC ratio (x) + profit In Rs: Sales price (x) = FC + VC + profit or, sales price (x) = FC + VC rate (x) + profit
By Ghanendra Fago (M. Phil, MBA) For AIM

15

Cost Volume Profit Analysis Under Changing Situations - Sensitivity Analysis

Sensitivity analysis is the measurement of responsiveness in outcome with the change in determination variables. As the goal of a business, enterprise is to maximize profits. Profits are the excess of revenue over the total costs To measure the sensitivity of CVP factors, the impact of certain percentage of change in volume, price, or cost factor on net profits must take into consideration.

By Ghanendra Fago (M. Phil, MBA) For AIM

16

Change in selling price

The change in selling price will affect the profit volume ratio and thus the break-even point. An increase in selling price will increase the PV ratio and will lower the break-even point. The reverse will have opposite effect i.e., decrease in selling price will reduce PV ratio and it results in to higher BEP.

By Ghanendra Fago (M. Phil, MBA) For AIM

17

Change in variable costs

The change in variable costs has an opposite

reaction to the PV ratio i.e. decrease in variable cost result in increase in PV ratio, whereas increase in variable cost shall result in decrease in the PV ratio. A decrease in PV ratio results into higher BEP and reduced profit and vice-versa.

By Ghanendra Fago (M. Phil, MBA) For AIM

18

Change in fixed costs

A change in fixed cost does not have any effect on the PV ratio but it affects the breakeven point and ultimately the profit. A decrease shall lower the BEP and increase the profit. Any increase pushes the breakeven point and reduces the profits.

By Ghanendra Fago (M. Phil, MBA) For AIM

19