Cost-Volume-

Profit Analysis

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 COST-VOLUME-PROFIT ANALYSIS

Cost-Volume-Profit (CVP) analysis is a

financial management tool and accounting
technique used by businesses to
understand the relationships between
costs, volume, and profits. It is also known
as break-even analysis because one of its
primary objectives is to determine the
level of sales or output at which a
business breaks even
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• CVP analysis is a valuable tool for business
decision-making. It can be used to:
• 1. Set pricing strategies,
• 2. Assess the impact of cost changes,
• 3. Evaluate the feasibility of new products or
ventures, and
• 4. Understand the relationship between
sales and profit..

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COST-VOLUME-PROFIT ANALYSIS

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CVP Relationships and
the Income Statement

A. Traditional Format
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 20x1

Sales $500,000
Less: 380,000
Gross margin $120,000
Less: Operating expenses:
Selling expenses $35,000
Administrative expenses 35,000 70,000
Net income $50,000

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CVP Relationships and
the Income Statement
B. Contribution Format
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 20x1

Sales $500,000
Less: Variable expenses:
Variable manufacturing $280,000
Variable selling 15,000
Variable administrative 5,000 300,000
Contribution margin $200,000
Less: Fixed expenses:
Fixed manufacturing $100,000
Fixed selling 20,000
Fixed administrative 30,000 150,000
Net income $50,000

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7-7
WHAT IS BREAK-EVEN
POINT?

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WHAT IS BREAK-EVEN POINT?

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 The Break-Even Point
The break-even point is the point in the
volume of activity where the organization’s
revenues and expenses are equal.

Sales $ 250,000
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 100,000
Net income $ -

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 Learning
Objective
2

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 CONTRIBUTION MARGIN
CONTRIBUTION MARGIN is the difference
between the entity’s sales and total variable
costs.
If selling price per unit is deducted with the
variable costs per unit, it becomes
contribution margin per unit. When
contribution margin is divided to sales, a
percentage is obtained called contribution
margin ratio.

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 CONTRIBUTION MARGIN
The contribution margin represents the portion
of revenue that is available to cover fixed
costs (such as rent, salaries, and etc.) and
contribute to profit. It's a valuable metric for
assessing the profitability of specific
products or services because it helps
companies understand how much money is
left over after covering the variable costs.

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 CONTRIBUTION MARGIN
NOTE: A higher contribution
margin indicates that a
product or service is more
profitable, as it has a greater
contribution to cover fixed
costs and generate a profit.
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 Contribution-Margin Approach
Consider the following information
developed by the accountant at Curl, Inc.:
For each additional surf board sold,
Curl generates $200 in contribution
margin.

Total Per Unit Percent

Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000

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If selling price per unit is
deducted with the variable
costs per unit, it becomes
contribution margin per
unit.

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 Contribution-Margin Approach

Fixed expenses Break-even point

=
Unit contribution margin (in units)

Total Per Unit Percent

Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000

$80,000
= 400 surf boards
$200
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 Equation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit

Unit Sales Unit Sales

sales × volume variable × volume
price in units expense in units

($500 × X) – ($300 × X) – $80,000 = $0

($200X) – $80,000 = $0
X = 400 surf boards
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 Contribution-Margin Approach

Here is the proof!

Total Per Unit Percent

Sales (400 surf boards) $200,000 $ 500 100%
Less: variable expenses 120,000 300 60%
Contribution margin $ 80,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ -

400 × $500 = $200,000 400 × $300 = $120,000

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When contribution margin is
divided to sales, a
percentage is obtained
called contribution margin
ratio.

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 Contribution Margin Ratio

Calculate the break-even point in sales peso rather

than units by using the contribution margin ratio.

Contribution margin
= CM
Sales
Ratio
Fixed expense Break-even point
=
CM Ratio (in sales peso)

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 Contribution Margin Ratio

Total Per Unit Percent

Sales (400 surf boards) $200,000 $ 500 100%
Less: variable expenses 120,000 300 60%
Contribution margin $ 80,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ -

$80,000
= $200,000 sales
40%
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7-23
BEP FORMULA

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PROBLEM

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7-26
7-27
7-28
7-29
 Learning
Objective
3

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Graphing Cost-Volume-Profit
Relationships
Viewing CVP relationships in a graph gives
managers a perspective that can be obtained in
no other way.
Consider the following information for Curl, Inc.:

300 units 400 units 500 units

Sales $ 150,000 $ 200,000 $ 250,000
Less: variable expenses 90,000 120,000 150,000
Contribution margin $ 60,000 $ 80,000 $ 100,000
Less: fixed expenses 80,000 80,000 80,000
Net income (loss) $ (20,000) $ - $ 20,000

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 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000

250,000
Dollars

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

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 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000

250,000
Dollars

200,000
se s
p e n
l e x
150,000 Tot a
100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

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 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000

250,000
Dollars

200,000
se s
p e n
l e x
150,000 Tot a
100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

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 Cost-Volume-Profit Graph
450,000

400,000
le s
350,000 l s a
a
Tot
300,000

250,000
Dollars

200,000
se s
p e n
l e x
150,000 Tot a
100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-35
 Graphing Cost-Volume-Profit
Relationships
Viewing CVP relationships in a graph gives
managers a perspective that can be obtained in
no other way.
Consider the following information for Curl, Inc.:

300 units 400 units 500 units

Sales $ 150,000 $ 200,000 $ 250,000
Less: variable expenses 90,000 120,000 150,000
Contribution margin $ 60,000 $ 80,000 $ 100,000
Less: fixed expenses 80,000 80,000 80,000
Net income (loss) $ (20,000) $ - $ 20,000

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 Cost-Volume-Profit Graph
450,000

400,000
le s
l s a a
350,000 a re
Break-even Tot fi t a
300,000
point Pr o
250,000
Dollars

200,000
se s
p e n
l e x
150,000 Tot a
Fixed expenses
r ea
100,000
s a
50,000
L os

100 200 300 400 500 600 700 800

Units

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 Profit-Volume Graph
Some
Some managers
managers like like the
the profit-volume
profit-volume
graph
graph because
because itit focuses
focuses onon profits
profits and
and volume.
volume.
100,000

80,000

60,000
Break-even
point r ea
it a
40,000

r of
20,000 P
Profit

0 `

(20,000) 100 200 300 400 500 600 700

r ea Units
(40,000) s a
os
(60,000)
L

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 Learning
Objective
4

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Contribution-Margin Approach
Consider the following information
developed by the accountant at Curl, Inc.:
For each additional surf board sold,
Curl generates $200 in contribution
margin.

Total Per Unit Percent

Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000

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 Desired/Target Net Profit

We can determine the number of surfboards

that Curl must sell to earn a profit of $100,000
using the contribution margin approach.

Fixed expenses + Target profit Units sold to earn

=
Unit contribution margin the target profit

$80,000 + $100,000
= 900 surf boards
$200

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CVP ANALYSIS WITH TARGET INCOME

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PROBLEM

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SOLUTION REQ. 1

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SOLUTION REQ. 2

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 Applying CVP Analysis
Margin of Safety/Safety Margin
• The difference between budgeted
sales/actual sales and break-even sales
revenue.
• The amount by which sales can drop before
losses begin to be incurred.

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MARGIN OF SAFETY

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PROBLEM

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7-49
7-50
7-51
7-52
Margin of Safety/Safety Margin
Curl, Inc. has a break-even point of $200,000.
If actual sales are $250,000, the safety margin is
$50,000 or 100 surf boards.

Break-even
sales Actual sales
400 units 500 units
Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net income $ - $ 20,000

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 Changes in Fixed Costs

•• Curl
Curl is
is currently
currently selling
selling 500
500 surfboards
surfboards per
per
year.
year.
•• The
The owner
owner believes
believes that
that an
an increase
increase of
of
$10,000
$10,000 in in the
the annual
annual advertising
advertising budget,
budget,
would
would increase
increase sales
sales toto 540
540 units.
units.

 Should
Should the
the company
company increase
increase the
the advertising
advertising
budget?
budget?
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 Changes in Fixed Costs

Current Proposed
Sales Sales
(500 Boards) (540 Boards)
Sales $ 250,000 $ 270,000
Less: variable expenses 150,000 162,000
Contribution margin $ 100,000 $ 108,000
Less: fixed expenses 80,000 90,000
Net income $ 20,000 $ 18,000

540
540 units
units ×× $500
$500 per
per unit
unit == $270,000
$270,000

$80,000
$80,000 ++ $10,000
$10,000 advertising
advertising == $90,000
$90,000
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 Changes in Fixed Costs

Sales
Sales will
will increase
increase by
by Current Proposed
$20,000,
$20,000, but
but net
net income
income Sales Sales
decreased
decreased byby $2,000.
$2,000. (500 Boards) (540 Boards)
Sales $ 250,000 $ 270,000
Less: variable expenses 150,000 162,000
Contribution margin $ 100,000 $ 108,000
Less: fixed expenses 80,000 90,000
Net income $ 20,000 $ 18,000

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 Contribution-Margin Approach
Consider the following information
developed by the accountant at Curl, Inc.:
For each additional surf board sold,
Curl generates $200 in contribution
margin.

Total Per Unit Percent

Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000

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 Changes in Unit
Selling Price

Suppose Curl, Inc. increases the price of

each surfboard to $550. With no change
in variable cost per unit, what will be the
new break-even point?

($550 × X) – ($300 × X) – $80,000 = $0

X = 320 units

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Changes in Variable Expense per
unit

Because of increases in cost of raw materials,

Curl’s variable cost per unit has increased
from $300 to $310 per surfboard. With no
change in selling price per unit, what will be
the new break-even point?

($500 × X) – ($310 × X) – $80,000 = $0

X = 421 units (rounded)

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 Predicting Profit Given
Expected Volume
In the coming year, Curl’s owner expects to sell
525 surfboards. The unit contribution margin is
expected to be $190, and fixed costs are
expected to increase to $90,000.

Total contribution - Fixed cost = Profit

($190 × 525) – $90,000 = X

X = $99,750 – $90,000
X = $9,750 profit
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 Learning
Objective
5

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 CVP Analysis with Multiple
Products
For a company with more than one product,
sales mix is the relative combination in which a
company’s products are sold.
Different products have different selling prices,
cost structures, and contribution margins.

Let’s assume Curl sells surfboards and sail

boards and see how we deal with break-
even analysis.

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CVP Analysis with Multiple Products
Curl provides us with the following
information:
Unit Unit Number
Selling Variable Contribution of
Description Price Cost Margin Boards
Surfboards $ 500 $ 300 $ 200 500
Sailboards 1,000 450 550 300
Total sold 800

Number % of
Description of Boards Total
Surfboards 500 62.5% (500 ÷ 800)
Sailboards 300 37.5% (300 ÷ 800)
Total sold 800 100.0%

NOTE: FIXED EXPENSES IS $170,000

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 CVP Analysis with Multiple
Products
Weighted-average unit contribution margin
Contribution Weighted
Description Margin % of Total Contribution
Surfboards $ 200 62.5% $ 125.00
Sailboards 550 37.5% 206.25
Weighted-average contribution margin $ 331.25

$200 × 62.5%

$550 × 37.5%
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 CVP Analysis with Multiple
Products
Break-even point
Break-even Fixed expenses
=
point Weighted-average unit contribution margin

Break-even $170,000
=
point $331.25

Break-even
= 514 combined unit sales
point

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CVP Analysis with Multiple
Products
Break-even point
Break-even
= 514 combined unit sales
point

Breakeven % of Individual
Description Sales Total Sales
Surfboards 514 62.5% 321
Sailboards 514 37.5% 193
Total units 514

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PROBLEM

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 Learning
Objective
6

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Assumptions Underlying
CVP Analysis
1. Selling price is constant throughout
the entire relevant range.
2. Costs are linear over the relevant
range.
3. In multi-product companies, the
sales mix is constant.
4. In manufacturing firms, inventories
do not change (units produced =
units sold).

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 Learning
Objective
8

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Cost Structure and Operating
Leverage
• The cost structure of an organization is the
relative proportion of its fixed and variable
costs.
• Operating leverage is . . .
–– the
the extent
extent toto which
which an
an organization
organization uses
uses fixed
fixed
costs
costs in
in its
its cost
cost structure.
structure.
– have a high proportion of fixed costs in
relation to variable costs.

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OPERATING LEVERAGE

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DEGREE OF OPERATING LEVERAGE
FORMULA

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Measuring Operating Leverage
Operating leverage Contribution margin
=
factor Net income
Actual sales
500 Board
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 80,000
Net income $ 20,000

$100,000
= 5
$20,000
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Measuring Operating Leverage
A measure of how a percentage change in
sales will affect profits. If Curl increases its
sales by 10%, what will be the percentage
increase in net income?

Percent increase in sales 10%

Operating leverage factor × 5
Percent increase in profits 50%

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Measuring Operating Leverage

A firm with proportionately high fixed costs has

relatively high operating leverage. On the other
hand, a firm with high operating leverage has a
relatively high break-even point.
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PROBLEM

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SOLUTION

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THANK YOU!
We made
it!

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