M5 CVPCMLimitingFactor

Identify the different types of costs (fixed, Discuss the uses of break-even data;
variable and mixed costs
Prepare a cost–volume–profit (CVP) Understand the concept of Optimization of

analysis for single-product and multi- resources (allocation of resources per limiting
product entities; factor).
Explain the key assumptions underlying CVP

analysis
CVP (Cost – Volume – Profit) analysis is concerned with the change in profits in response to
changes in sales volumes, costs and prices
Helps answer the following questions:
• How many units need to be sold, or services performed, to break even (for example, earn
zero profit)?
• What is the impact on profit of a change in the mix between fixed and variable costs?
• How many units need to be sold, or services performed, to achieve a particular level of
profit?
• What is the impact on profit of a 15 per cent increase in costs?

Examining cost behaviour enables us to consider:
• The way in which costs change, and
• The main factors that influence those changes.
Costs can be classified as fixed, variable or mixed.
The nature of fixed and variable costs relates to whether

such costs are likely to alter in total with changes in
activity.
Fixed costs are those costs which remain the same in total (within a given range of activity and time
frame) irrespective of the level of activity.
• e.g. lease costs, depreciation charges.
When we consider levels of activity in terms of units of output:
• Total fixed costs remain the same, but.
• Fixed costs per unit will decrease as the number of units produced increases.
Fixed costs behaviour
Total Fixed Costs Fixed Costs per Unit

Variable costs change in total as the level of activity
changes, example:
• Costs of bricks to build a house
• Aviation fuel for Qantas
Variable costs can be considered on either a

total or unit basis.
Variable costs behaviours
Total Variable Costs Variable Costs per Unit

P = SP (X) – VC (X) – FC
Revenues Expenses
P = Profit
SP = Selling Price
VC = Variable Cost
FC = Fixed Cost
X = Number of Units being sold
The CVP formula essentially says Profits = Revenue - Expenses

• Break-even analysis involves the contribution margin concept
• Contribution margin (per unit) can be calculated by deducting variable cost per unit from revenue per
unit.
Contribution margin = SP – VC
• “Total Contribution margin” is calculated by deducting total variable costs from total revenue
Total Contribution margin = SP(X) – VC(X)

Break-even analysis relates to the calculation of the necessary levels of activity required in order to
break even in a given period.
Break-even occurs when total revenue and total costs are equal resulting in zero profit
i.e. when.
Revenues = Fixed Costs + Variable Costs
SP(X) = FC + VC(X)
OR When P = 0
The formula for breakeven is: Breakeven units = FC

CM
Breakeven dollars = Breakeven units x SP

Example 1 Calculate break-even Units to earn a desired profit
Example 1
• Selling price $25
• Purchase price $14
• Fixed exhibition and trade show costs $28 000 p.a.
• Fixed transport costs $10 600 p.a.
• Variable demonstration costs $1 per unit
• Administration fixed costs $6 400 p.a.
Calculate Break-even (in units)

Example 1 Calculate break-even Units to earn a desired profit
SP per unit $25

VC per unit
Purchase price $14
Demonstration costs $1
15
CM per unit $10
Break-even = FC
CM per unit
= $(28 000 + 10 600 + 6 400)
$10
= $45 000
$10
= 4500 units
Example 1 Calculate Break-even Units to earn a desired profit
FC + Expected profit = x sales units

CM per unit
Example 1
Expected profit (before tax) $50 000
FC + P = $(45 000 + 50 000)

CM per unit $10
= 9 500 units
Example 1 Calculate Break-even Units to earn a desired profit Analysis
VC increased to $17 per unit

FC reduced to $32 000
CM = $25 – $17 = $8
Break-even = $32 000 = 4000 units
$8
Can also be expressed in an equation format
sp(x) = vc(x) + fc (for break-even)
sp(x) = vc(x) + fc + p (for meeting desired profit)

= CM
Contribution Margin Ratio
SP
“For every $1 of Revenue: How much profit are we making”
If the CM Ratio is 0.4 then for every Dollar of Sales, the profit is 40c
If the CM Ratio is 0.05 then for every Dollar of Sales, the profit is 5c
If the CM Ratio is 0.05 and our sales were $40,000 then our total profit is $2,000
Break-even data can be used to assist with a variety of decision situations, including:
• Identifying the number of products or services required to be sold to meet break-even or profit
targets
• Planning products and allocating resources by focusing on those products that contribute more
to profitability
• Determining the impact on profit of changes in the mix of fixed and variable costs
• Pricing products.
Contribution margin per limiting factor is the contribution margin per unit of limited resource.
Example 2
Products
B101 C101 D101
Budgeted sales next year 60 000 40 000 100 000
SP per unit $25 $30 $20
VC per unit $15 $22 $15
CM per unit $10 $8 $5
Labour time per unit 1 hr 4 hrs 1.5 hrs
Total labour hrs required 60 000 hrs 160 000 hrs 150 000 hrs
Example 2
• By summing the required hours, we find that the firm needs a total of 370 000
hours
• BUT let’s assume only 250 000 hours are available for production
• Firm wants to know which product it should promote
• This means we need to determine the most profitable product
• To do this need to find CM per hour because time is the limiting factor
Example 2
B101 C101 D101

CM per unit $10 $8 $5
Labour time per unit 1 hr 4 hrs 1.5 hrs
Total labour hrs required 60 000 hrs 160 000 hrs 150 000hrs
CM per hour $10 p.h. $2 p.h. $3.33 p.h.
This analysis shows that:
• B101 is the most profitable by providing more CM per hour.
• ModClean should therefore focus production on B101 (60,000 hours) followed by D101 (150,000 hours)
since this is the second most profitable.
• The remaining 40,000 hours (250,000 – 210,000 hours) allocated towards C101.

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Identify the different types of costs (fixed, Discuss the uses of break-even data;

variable and mixed costs

Prepare a cost–volume–profit (CVP) Understand the concept of Optimization of

Explain the key assumptions underlying CVP

Helps answer the following questions:

• What is the impact on profit of a 15 per cent increase in costs?

• The way in which costs change, and

• The main factors that influence those changes.

Costs can be classified as fixed, variable or mixed.

The nature of fixed and variable costs relates to whether

• e.g. lease costs, depreciation charges.

When we consider levels of activity in terms of units of output:

• Total fixed costs remain the same, but.

Total Fixed Costs Fixed Costs per Unit

• Costs of bricks to build a house

• Aviation fuel for Qantas

Variable costs can be considered on either a

Total Variable Costs Variable Costs per Unit

The CVP formula essentially says Profits = Revenue - Expenses

Total Contribution margin = SP(X) – VC(X)

The formula for breakeven is: Breakeven units = FC

Breakeven dollars = Breakeven units x SP

Calculate Break-even (in units)

SP per unit $25

FC + Expected profit = x sales units

Expected profit (before tax) $50 000

FC + P = $(45 000 + 50 000)

VC increased to $17 per unit

Can also be expressed in an equation format

sp(x) = vc(x) + fc (for break-even)

sp(x) = vc(x) + fc + p (for meeting desired profit)

“For every $1 of Revenue: How much profit are we making”

• Firm wants to know which product it should promote

• This means we need to determine the most profitable product

B101 C101 D101

This analysis shows that:

• B101 is the most profitable by providing more CM per hour.

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