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    If There Is An Increase In.... Then Profit Tends To......

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    glcpa
    CVP analysis examines the relationship between costs, volume, and profits. Key factors like selling price, variable costs, fixed costs, and sales volume impact profits. CVP uses concepts like contribution margin, break-even point, margin of safety, and degree of operating leverage. It provides a framework for profit planning and analysis under different assumptions. Examples demonstrate calculating break-even units and sales, required sales to achieve a target profit, indifference points, and the impact of operating leverage on profits from increased sales.

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    If There Is An Increase In.... Then Profit Tends To......

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    glcpa
    4K views5 pages
    CVP analysis examines the relationship between costs, volume, and profits. Key factors like selling price, variable costs, fixed costs, and sales volume impact profits. CVP uses concepts like contribution margin, break-even point, margin of safety, and degree of operating leverage. It provides a framework for profit planning and analysis under different assumptions. Examples demonstrate calculating break-even units and sales, required sales to achieve a target profit, indifference points, and the impact of operating leverage on profits from increased sales.

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    CVP analysis examines the relationship between costs, volume, and profits. Key factors like selling price, variable costs, fixed costs, and sales volume impact profits. CVP uses concepts like contribution margin, break-even point, margin of safety, and degree of operating leverage. It provides a framework for profit planning and analysis under different assumptions. Examples demonstrate calculating break-even units and sales, required sales to achieve a target profit, indifference points, and the impact of operating leverage on profits from increased sales.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    4K views5 pages

    If There Is An Increase In.... Then Profit Tends To......

    Uploaded by

    glcpa
    CVP analysis examines the relationship between costs, volume, and profits. Key factors like selling price, variable costs, fixed costs, and sales volume impact profits. CVP uses concepts like contribution margin, break-even point, margin of safety, and degree of operating leverage. It provides a framework for profit planning and analysis under different assumptions. Examples demonstrate calculating break-even units and sales, required sales to achieve a target profit, indifference points, and the impact of operating leverage on profits from increased sales.

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    of 5

    COST-VOLUME-PROFIT (CVP) ANALYSIS

    CVP analysis is useful for profit planning by way of a systematic analysis of the profit's relationship
    with various costs and volume of sales.

    FACTORS AFFECTING PROFIT


    If there is an increase in.... Then Profit tends to.......
    1. Selling price Increase
    2. Unit Variable cost Decrease
    3. Fixed cost Decrease
    4. Volume (Unit Sales) Increase

    In multi-product companies, a change in sales mix may also affect company profit.

    LIMITATIONS and ASSUMPTIONS of CVP analysis


    1. Relevant range, time and linearity assumptions COST BEHAVIOR ANALYSIS are also assumed in CVP analysis.
    2. Unless indicated otherwise, unit selling price is constant even if sales volume changes.
    3. Inventories do not change significantly from period to period.
    4. In case of a multi-product company, sales mix is constant.
    5. Labor productivity, production technology and market conditions remain stable.

    TERMINOLOGIES USED IN CVP ANALYSIS


    1. Contribution Margin (CM) is the difference between sales and variable cost. It is otherwise known as marginal
    income, profit contribution, contribution to fixed cost or incremental contribution.

    CM Ratio = CM / Sales = Unit CM/ Unit SP= change in CM/ Change in Sales

    2. Break-Even Point (BEP) - a level of activity, in units (break-even volume) or in pesos (break-even sales), at which
    total revenues equal total costs. At the break-even point, there is neither a profit nor a loss.

    BEP units = Fixed Costs / CM per unit


    BEP peso sales= Fixed Costs / CM Ratio
    Unit Sales With Target Profit = (Fixed Costs + Profit* ) / CM per Unit
    Peso Sales with Target Return on Sales = Fixed Costs/ (CM Ratio- Return on Sales)

    * Profit must be expressed before tax: Profit after tax/ (100% - tax rate)

    3. Margin of Safety (MOS)- the difference between actual sales and break-even sales. It indicates the maximum
    amount by which sales could decline without incurring a loss.

    Margin of Safety = Sales — Breakeven Sales


    Margin of Safety Ratio= Margin of Safety / Sales

    4. Indifference Point — the level of volume at which two alternatives being analyzed would yield equal amount of
    total costs or profits.
    Alternative A Alternative B

    (Unit CM x Q) - Fixed Cost = (Unit CM x Q) - Fixed Cost

    Fixed Cost + (Unit VC x Q) = Fixed Cost + (Unit VC x Q)

    NOTE: Q number of units (indifference point)

    5. Sales Mix- the relative combination of quantities of sales of various products that make up the total sales of a
    company

    Over-all BEP in units = Fixed Costs / Weighted Average CM per unit


    Over-all BEP peso sales= Fixed Costs / Weighted Average CM Ratio

    6. Degree of Operating Leverage (DOL)- measures how a percentage change in sales will affect company profits. It
    indicates how sensitive the company if sales volume increases and decreases. It is also known as operating leverage
    factor.

    DOL = Contribution margin / Profit before tax


    change in % of sales x DOL = change in % profit before tax

    Example 1:
    AAA Company manufactures and sells a single product. The company's sales and expenses for a recent month
    follows:

    Sales (1,500 units) P 37,500


    Less: Variable Costs 15,000
    Contribution Margin P 22,500
    Less: Fixed Costs 15,000
    Profit P 7,500

    REQUIRED:

    1. Determine the following:


    A.Unit selling price 37,500/1,500=P25
    B. Unit variable cost 15,000/1,500=P10
    C. Contribution margin ratio (CMR) 22,500/37,500=60%

    2. For profit planning purposes, compute the following:


    A) Break-even point in units 15,000/15=1,000 units x 25= P25,000
    B) Break-even peso sales 15,000/0.60=P25,000

    3. What unit sales are required to earn P 6,000 profit for the month? (15,000 + 6,000)/15= 1,400 units

    4. What peso sales are required to earn an after-tax profit of P 3,750 (assuming tax rate is 25%)?
    15,000 + (3,750/.75) / 0.60 = P33,333
    5. Assume that AAA is currently selling 800 units per month and that the company president believes that sales would
    increase if advertising were increased by P 6,000. How many units should sales increase to give AAA the same profit
    or loss that it is currently earning? P6,000/15=400 units

    Sales 25x 400= 10,000


    VC 10x400= 4,000
    CM = 6,000
    FC 6,000
    Ni/Nl 0

    6. What is the margin of safety at its present sales of P 37,500? 37,500-25,000= P12,500

    7. AAA currently pays its salespeople a monthly salary of P 4,000 per month without any commission. However, the
    company considers a plan whereby the salespeople would receive a 10% commission, but the monthly salary would
    fall to P 2,500. What sales level will the company be indifferent between the two compensation plans?

    Monthly fixed cost will decrease by P 1,500 under the proposal (P 4,000 ----> P 2,500).
    Unit variable cost increases by P 2.50 =(10% of P 25)

    Based on cost function "Y = a + bX"


    Costs (old) = Costs (new)
    1 15,000 + 10x = 13,500 +12.5x
    x = 600 units

    2 15X-15,000=12.5x-13,500
    15x-12.5x=15,000-13,500
    2.5x=1,500
    x=600 units

    To proved:
    4,000= 2,500 + (600x25x10%)
    4,000= 2,500 + 1,500
    4,000=4,000

    PROVING:

    Contribution margin ratio x Margin of safety ratio= Net profit ratio


    Where:
    CMR= CM/Sales
    MOSR= MOS/Sales
    NPR= Profit /Sales

    Example 2:
    BBB's break-even sales are P 528,000. The variable cost ratio is 60% while the profit ratio is 8%.

    REQUIRED: Determine the following:


    1. Fixed Costs 528,000 x 0.40= P211,200
    2. Sales 211,200/ 40%-8%= P660,000
    3. Profit P660,000 x 8%= 52,800
    4. Margin of Safety P660,000-528,000= P132,000
    5. Margin of Safety Ratio P132k/ P660k= 20% or .4x=.08 =0.20 or 20%

    Example 3:
    CCC Company produces and two products, tables and chairs. Following is next month's income budget:
    Chairs Tables Total
    Unit Sales 60 u 15 u 75 u
    Sales P1,200 P187.50 P1,387.50
    Variable Cost 1,050 112.5 1,162.50
    Contribution margin P150 P75 P225
    Fixed costs 90
    Profit P135

    REQUIRED:
    A. How many units of chairs should be sold next month to breakeven?

    Chairs Tables
    CM/unit 2.50 5.00
    Sales mix 4:1 80% 20%
    Weighted average CM/ unit 2 1

    Fixed cost 90
    WACM/u /3
    BEP in units 30 units
    Sales mix of Chairs x80%
    24 units

    B. How many units of tables should be sold to earn a profit of P 180?

    (90 + 180)/ 3= 90 x 0.20= 18 units

    Example 4:
    DDD has recently opened the G n G Fitness Gym being offered exclusively for malnourished millennials.

    The income statement for its first year of operations


    Sales P 250,000
    Variable Costs (100,000)
    Contribution Margin P 150,000
    Fixed Costs (120,000)
    Profit P 30,000

    DDD is unhappy about the results of his gym’s first year of operations. She observed that despite the high contribution
    margin, profit was still low because of the high fixed costs. She concludes that an increase in sales would not yield a
    satisfactory increase in profit.
    REQUIRED:
    A. Explain to DDD that his conclusion is not right by computing the operating leverage factor.
    DOL = CM/ Profit before tax
    =150,000/ 30,000
    =5 times

    B. If sales increase by 10%, then how many percent would profit increase?
    change in % of sales x DOL = change in % profit before tax
    10% x 5 = 50%

    100% +10%
    Sales 250,000 275,000
    Variable Cost 100,000 110,000
    Contribution Margin 150,000 165,000
    Fixed cost 120,000 120,000
    Profit 30,000 45,000

    45/30= 150%

    Example 5:
    Star Company plans to sell 400,000 unit. The fixed costs are 600,000 and variable costs is 60% of the selling price. If
    the company wants to realize a profit of 120,000. How much would be the selling price per unit?

    600,000 + 120,000 / 0.40 / 400,000= P4.50

    Quiz:

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