Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume affect operating and net income. Key assumptions in CVP analysis include constant sales price and variable costs per unit, total fixed costs remaining constant, everything produced being sold, and costs only changing due to activity levels. CVP analysis requires identifying all costs as either variable or fixed. Key calculations are contribution margin (sales revenue - variable costs) and contribution margin ratio (contribution margin/sales). Break-even point is where sales revenue covers total costs. Margin of safety is sales above break-even point. CVP analysis is used to determine sales levels needed to reach profit targets or break even.
Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume affect operating and net income. Key assumptions in CVP analysis include constant sales price and variable costs per unit, total fixed costs remaining constant, everything produced being sold, and costs only changing due to activity levels. CVP analysis requires identifying all costs as either variable or fixed. Key calculations are contribution margin (sales revenue - variable costs) and contribution margin ratio (contribution margin/sales). Break-even point is where sales revenue covers total costs. Margin of safety is sales above break-even point. CVP analysis is used to determine sales levels needed to reach profit targets or break even.
Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume affect operating and net income. Key assumptions in CVP analysis include constant sales price and variable costs per unit, total fixed costs remaining constant, everything produced being sold, and costs only changing due to activity levels. CVP analysis requires identifying all costs as either variable or fixed. Key calculations are contribution margin (sales revenue - variable costs) and contribution margin ratio (contribution margin/sales). Break-even point is where sales revenue covers total costs. Margin of safety is sales above break-even point. CVP analysis is used to determine sales levels needed to reach profit targets or break even.
Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume affect operating and net income. Key assumptions in CVP analysis include constant sales price and variable costs per unit, total fixed costs remaining constant, everything produced being sold, and costs only changing due to activity levels. CVP analysis requires identifying all costs as either variable or fixed. Key calculations are contribution margin (sales revenue - variable costs) and contribution margin ratio (contribution margin/sales). Break-even point is where sales revenue covers total costs. Margin of safety is sales above break-even point. CVP analysis is used to determine sales levels needed to reach profit targets or break even.
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CVP Analysis
Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume affect a company's operating income and net income. In performing this analysis, there are several assumptions made, including:
Sales price per unit is constant.
Variable costs per unit are constant. Total fixed costs are constant. Everything produced is sold. Costs are only affected because activity changes. If a company sells more than one product, they are sold in the same mix. CVP analysis requires that all the company's costs, including manufacturing, selling, and administrative costs, be identified as variable or fixed. Contribution margin and contribution margin ratio Key calculations when using CVP analysis are the contribution margin and the contribution margin ratio. The contribution margin represents the amount of income or profit the company made before deducting its fixed costs. Contribution Profit Volume Ratio (P/V Ratio or Contribution/Sales (C/S)) Break-Even Point Margin of Safety
where the sales revenue at break-even point = Fixed cost + Variable cost
This equation can be restated as follows:
Profit = (Unit sales price x Sales volume in units) – (Unit variable cost x Sales volume in units) – Fixed costs
Break-Even point (units) = Fixed Costs ÷ (Sales price per unit – Variable costs per unit) where: CM=Contribution margin=Sales−Variable Costs
Examples #1 XYZ wishes to make an annual profit of $100000 from the sale of appliances. Details of manufacturing and annual capacity are as follows:
Based on the above information, let’s plug the numbers in the CVP equation:
10000*p= (10000*30) +$30000+$100000
10000p = ($300000+$30000+$100000) 10000p=$430000 Price per unit= ($430000/10000) = $43 Thus price per unit comes out to $43, which implies that XYZ will have to price its product $43 and need to sell 10000 units to achieve its targeted profit of $100000. Further, we can see that the fixed cost remains constant ($30000) irrespective of the level of sales.
Examples #2 ABC Limited has entered into the business of making Electrical fans. The management of the company is interested in knowing the breakeven point at which there will be no profit/loss. Below are the details pertaining to the cost incurred:
Solution:
No. of units sold by ABC limited: ($300000/$300) = 1000 units
Variable cost per unit= ($240000/1000)=$240
Contribution per unit= Selling price per unit-Variable cost per unit = ($300-$240) = $60 per unit Break-Even Point= (Fixed Cost/Contribution per unit)
= ($60000/$60) =10000 units Thus ABC limited the need to sell 10000 units of electric fans to break even at the current cost structure.
Contribution Margin Ratio = Contribution Margin/Sales
The contribution margin is sales revenue minus all variable costs. It may be calculated using dollars or on a per unit basis. QUESTION 4: Calculate BEP
If The Three M's, Inc., has sales of $750,000 and total variable costs of $450,000. Assuming the company sold 250,000 units during the year & the per unit sales price is $3 and the total variable cost per unit is $1.80. . Calculate CM & CMR per unit n overall.
Calculate CMR , BEP SAles
CM = Sales – V. C = 750000 -450000 = 3,00000
1. CMR = CM /Sales = 3,00,000/750,000*100 =40%
2. BEP is sales =FC/CMR = 300,000/40% = 750,000
3. Break‐even point in units. = FC /CM @per unit
3,00,000/1.20 = 250,000 per unit
Targeted income CVP analysis is also used when a company is trying to determine what level of sales is necessary to reach a specific level of income, also called targeted income. To calculate the required sales level, the targeted income is added to fixed costs, and the total is divided by the contribution margin ratio to determine required sales dollars, or the total is divided by contribution margin per unit to determine the required sales level in units. Req. Sales in dollars = (FC +Targeted Income)/CMR
Req. Sales in units = (FC +Targeted Income)/CM @per unit
Example: Using the data from the previous example, what level of sales would be required if the company wanted $60,000 of income?
Req. Sales in dollars = (FC +Targeted Income)/CMR
= (3,00,000+ 60,000)/40% = Rs. 9,00,000
Req. Sales in units = (FC +Targeted Income)/CM @per unit
= (3,00,000+ 60,000)/1.20 = 3,00,000 units
Targeted Income After Income tax
This calculation of targeted income assumes it is being calculated for a division as it ignores income taxes. If a targeted net income (income after taxes) is being calculated, then income taxes would also be added to fixed costs along with targeted net income.
Req. Sales in dollars = (FC +Targeted Income+ Income Tax)/CMR
Req. Sales in units = (FC +Targeted Income + Income Tax)/CM @per unit
Example :Using the same data, The amount of income taxes used in the calculation is $40,000.
1. Req. Sales in dollars = (FC +Targeted Income+ Income Tax)/CMR
= (3,00,000+ 60,000 +40,000)/40% = Rs. 1,00,000
2. Req. Sales in units = (FC +Targeted Income+ Income Tax)/CMR @per unit
= (3,00,000+ 60,000 +40,000)/1.20 = 3,33,333 units
Profit-Volume Ratio Profit / Volume (P/V) ratio is calculated while studying the profitability of operations of a business and to establish a relation between Sales and Contribution. It is one of the most important ratios, calculated as under: P ⁄V Ratio or CMR = Contribution/Sales OR = Sales−Variable Cost/Sales OR = Fixed Expenses +Profit / sales OR = Change in profits of Contributions/Change in sales The P/V Ratio shares a direct relation with profits. Higher the P/V ratio, more the profit and vice-a-versa.
Margin of Safety Excess of sale at BEP is known as margin of safety. Therefore, Margin of safety = Actual Sales − Sales at BEP Margin of safety may be calculated with the help of the following formula: Margin of Safety = Profit / P/v ratio
OR = Profit/ Contribution per unit
Example:
Fixed Cost = Rs 2,50,000
Variable Cost = Rs 15 per unit Selling Price = Rs 25 per unit Production level in units 12,000, 15,000, 20,000, 25,000, 30,000, and 40,000. Calculate:
B.E.P in units , At production level of 25,000 units, the total cost, Statement showing Profit & Margin of safety at different level of production. Solution: 1. B.E.P in units = Fixed Cost/ contribution per unit = Rs 2,50,000 / (25-15) = Rs 2,50,000 / (10) = 25,000 units
2. At production level of 25,000 units, the total cost will be
Example: 1. Pepsi Company produces a single article. Following cost data is given about its product:‐ Selling price per unit Rs.40 V. cost per unit Rs.24 Fixed cost per annum Rs. 16000 Calculate: (a)P/V ratio (b) break even sales (c) sales to earn a profit of Rs. 2,000 (d) Profit at sales of Rs. 60,000 (e) New break even sales, if price is reduced by 10%.
Solution: We know that (S‐v) /S= F + P OR s x P/V Ratio = Contribution So,
(A) P/V Ratio = Contribution/sales x 100
= (40‐24)/40 x 100 = 16/40 x 100 OR 40% (B) Break even sales S = CM/P/v Ratio (At break even sales, contribution is equal to fixed cost) S = FC /P/v ratio Fixed Cost = S x P/V Ratio = S x 40/100 = 16,000 S = 16,000 x 100 / 40 = 40,000 OR 1000 units (C) The sales to earn a profit of Rs. 2,000 S x P/V Ratio = F + P S x 40/100 = 16000 + 2000 S = 18,000 x 100/40 S = Rs. 45,000 OR 1125 units
(D)Profit at sales of 60,000 S x P/V Ratio = F + P
Rs. 60,000 x 40/100 = 16000 + P 24,000 = 16000 + P 24,000 – 16,000 = P 8,000 ( E) New break even sales, if sale price is reduced by10% New sales price = 40‐10% = 40‐4 = 36 Marginal cost = Rs. 24 Contribution = (36-24)= Rs. 12 P/V Ratio = Contribution/Sales = 12/36 x100 OR 33.33% Now, S x P/V Ratio = F C (at B.E.P. contribution is equal to fixed cost) S x 100/300 = Rs.16000 S = 16000 x 300/100 S= Rs.48,000.
Example : From the following information's find out: a. P/V Ratio b. Sales & c. Margin of Safety Fixed Cost = Rs.40, 000 Profit = Rs. 20,000 B.E.P. = Rs. 80,000 Solution: a. P/V Ratio. BEP Sales = FC/PV Ratio 80,000 = 40,000/x X=50% b. Sales. Sales x P/V Ratio = F+ P OR Sales x P/V Ratio = Contribution OR Sales = Contribution/P/V Ratio So, = (40,000 + 20,000)/50/100 = (60,000 x 100)/50 =Rs.1, 20,000 c. Margin of Safety. Margin of Safety = Sales – B.E.P Sales So, MOS = 1, 20,000 – 80,000 MOS = Rs.40, 000
Example : - From the following data, you are required to calculate:
(a) P/V ratio (b) Break-even sales with the help of P/V ratio. (c) Sales required to earn a profit of Rs. 4,50,000 Fixed Expenses = Rs. 90,000 Variable Cost per unit: Direct Material = Rs. 5 Direct Labour = Rs. 2 Direct Overheads = 100% of Direct Labour Selling Price per unit = Rs. 12.
Example : -From the following data, you are required to calculate break- even point and net sales value at this point: If sales are 10% and 25% above the break even volume, determine the net profits. SOLUTION: Selling Price per unit 25 - Trade discout (25X4/100) 1 Net Selling price 24 - V.C D. Labour 5 D. Material 10 Vari. Overheads 3 (5X60/100) 18 Contri. Per unit 6 BEP ( in units) FC/ Contri. Per unit = 50,000/6 = 8333 units
BEP ( in Sales) = FC / P/V Ratio
P/V Ratio = (contr. /sales )x100 = (6/24) x 100 = 25% Therefore BEP S. = 50,000/25% = 2,00,000 Profit when sales is 10% above Break-even Value: Sales = 2,00,000 + (2,00,000 x10%) = 2,20,000 Contribution = sales / p/v Ratio = 2,20,000 /25% = 55,000 Contribution = FC + Profit 55,000 = 50,000 + profit Profit = 5,000 Profit when sales is 25% above Break-even Value: Sales = 2,00,000 + (2,00,000 x25%) = 2,50,000 Therefore BEP S. = 2,50,000/25% = 62,500 Contribution = FC + Profit 62,500= 50,000 + profit Profit = 12,500
case Study - 1 A manufacturing company produces Ball Pens that are printed with the logos of various companies. Each Pen is priced at `5. Costs are as follows: Cost Driver Unit Variable Cost (`) Level of Cost Driver Units Sold 2.5 Setups 225 40 Engineering hours 10 250 Other Data Total Fixed Costs (conventional)………………………………..` 48,000 Total Fixed Costs (ABC)………………………………………….` 36,500 Required (i) Compute the break-even point in units using activity-based analysis. (ii) Suppose that company could reduce the setup cost by ` 75 per setup and could reduce the number of engineering hours needed to 215. How many units must be sold to break even in this case? Solution: Break Even Units 1. [Fixed Costs + (Setup Cost ×Setups) + (Engineering Cost ×Engineering Hours)]/ (Sale Price − Variable Cost) = [36,500 + (` 225 × 40) + (`10 × 250)] / (` 5 – ` 2.5) = 19,200 units 2. [Fixed Costs + (Setup Cost ×Setups) + (Engineering Cost ×Engineering Hours)]/ (Sale Price − Variable Cost) = [36,500 + (`150 × 40) + (`10 × 215)] / (` 5 – ` 2.5) = 17,860 Units
