CVP ANALYSIS

An analysis of how cost and profit changes when volume

changes is known as
Cost – Volume – Profit analysis.

The Relationship
-Profit depends on selling price, cost of
manufacturing and volume of sale
-Selling price depends on cost of manufacturing
-Volume of sales depends on volume of production

The volume of production depends on cost

Profit = Selling price - Variable cost - Total fixed cost

 OBJECTIVES OF CVP
• To forecast profit fairly accurately
• Forecast sales volume to achieve a particular level of
profit
• To prepare flexible budgets where variable cost alone
changes
• If sales volume increases what would be the profit
• Effect on profit if fixed cost or variable cost changes
• Required sales volume to cover additional fixed charges
• And so many other business operation related decisions
 BREAK EVEN ANALYSIS
• The break even point is the sales volume at which there is
neither profit nor loss, costs being equal to revenue.
Fixed Cost
• Break Even (volume) = ---------------------
Contribution margin (Selling price – Variable cost per unit)

• It measures the amount each unit sold contributes to cover

fixed cost and increase profits.
Fixed Cost
• BEP (Amount) = -----------------
PV Ratio
 PROFIT VOLUME RATIO (PV Ratio)
• PV Ratio also known as contribution margin ratio, marginal income ratio or
variable profit ratio is useful;
a) For determining the desired volume of output for specified amount
of profit
b) To know changes in profit due to changes in volume

• A HIGHER PV RATIO INDICATES THAT A SIGNIFICANT INCREASE IN

VOLUME WITHOUT ANY INCREASE IN THE FIXED COST WOULD
RESULT IN HIGHER PROFITS
Contribution margin per unit
• PV ratio = ----------------------------------
Selling price per unit

• This indicates the contribution of every additional rupee of sales to cover

fixed cost and generating a profit
• If my fixed cost is Rs. 20,000 and PV ratio is 40 % the break even would be
Fixed cost 20,000
• --------------- = ----------- = Rs.50,000
PV Ratio 40%
 VV RATIO

• Variable cost to volume ratio indicates

relationship between variable cost and
sales volume.

• VV RATIO = 1 - PV ratio
 MARGIN OF SAFETY
• It is better to have a level of sales greater than break even sales.
Margin of safety is the difference between the expected or actual
level of sales and break even sales.
Actual sales – Break Even sales volume
• Margin of safety % = ------------------------------------------------ X 100
Actual sales

• A HIGHER MARGIN OF SAFETY SHOWS THAT BREAK EVEN

POINT IS MUCH BELOW THE ACTUAL SALES. EVEN IF THERE
IS A FALL IN SALES , THERE WILL STILL BE PROFIT.

• If Actual sales is Rs. 6,000 and Break Even Rs. 3,600 the MS ratio
would be 40%. This means actual sales may be reduced up to 40 %
to reach a break even level.

• Margin of safety can also be used to measure the amount of profit

• Profit = margin of safety amount X PV ratio

• If Margin of safety is Rs.2.400 and PV ratio is 33.335 THE PROFIT

WOULD BE Rs.800
 SALES VOLUME REQUIRED TO DESIRED
OPERATING PROFIT
Fixed cost + Desired operating profit
• Required sales volume = --------------------------------------------
PV Ratio

• Ex. Calculate desired level of operation from the following

figures assuming a tax rate of 40% and the net profit
expectation of 20% on capital of Rs. 2 Crore after tax)
( Rupees )
• Selling price per unit 400
• Variable cost 250
• Fixed cost
• Staff salaries for the year 12,00,000
• General office exp 13,00,000
• Depreciation on assets 10,00,000
• Other fixed expenses 2,50,000
Desire Income before tax i.e. operating income
• Expected profit 20% after tax on Rs. 2 crore = 40,00,000
Tax rate = 40%
Profit before tax = 40,00,000 X 100 = 66,66,667
60
• PV Ratio = Contribution margin per unit / selling price
= 400-250/ 400 = 0.375

• Fixed cost Rs. 37,50,000

37,50,000 + 66,66,667
• Required sales revenue = 0.375
•
= Rs.2,77,77,776
Desired level of output=2.77 crore/400=69444.44 units