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Md. Jaker Hossain Joint Director Foreign Exchange Inspection & Vigilance Department.

Cost Volume Pro it !CVP" #nal$sis%
&earning '()ecti*es%

1. What are the objectives of cost volume profit analysis (CVP Analysis)? 2. efine an! e"plain contribution mar#in an! contribution mar#in ratio. $.
efine% e"plain an! calculate brea&even point?

'. What is operatin# levera#e an! operatin# levera#e ratio? (. What are the assumptions of CVP analysis? ). What are the limitations of CVP analysis? *. What are a!vanta#es an! !isa!vanta#es of CVP Analysis
De inition% CVP analysis can be !efine! as the analysis that !eals +ith ho+ profits an! costs chan#e +ith a chan#e in volume. ,ore specifically% it loo&s at the effects on profits of chan#es in such factors as variable costs% fi"e! costs% sellin# prices% volume% an! mi" of pro!ucts sol!. +$pes o Expenses,Cost% Varia(le Cost- .hose cost that chan#e in total in !irect proportion to chan#es in the level of activity. An increase/(!ecrease) in activity brin#s proportional increase/(!ecrease) in total variable costs. 0"amples li&e !irect material costs an! !irect labor costs +hich increase in proportionate to the increase in the number of units manufacture!. 1n total absolute costs% total variable costs chan#es in proportionate to the chan#es in the level of activity but per unit variable costs remain constant across a reasona(le ran#e of activity Fixed Cost: .he cost +hich !oes not chan#es !epen!in# on the level of activity. 0"amples li&e !epreciation an! rental remain fi"e! irrespective of the level of activity. 2o% the 3i"e! Cost Per 4nit +ill vary at !ifferent level of activity Mixed ,-emi Fixed Cost- 1nclu!es both fi"e! an! variable costs elements. .o a certain e"tent% a cost can be semi fi"e! an! variable. .a&e for e"ample repair% maintenance an! electricity +hich in a +ay vary +ith the level of activity +hilst the other part !oes not.


.$$ Contribution mar#in 1$$.$$$.1. and /hat t$pe o producti*e acilities to ac0uire. the company's contribution margin & income statement will appear as follows: Particulars 2ales (1 4nit only) :ess Variable e"penses %ess &i'ed ('penses Total in T . .$$ 1#$. Contribution mar#in is first use! to cover the fi"e! e"penses an! then +hatever remains #o to+ar!s profits. "#$. has been able to sell only one unit of product during the period. Example: Assume that M/s ABC Co. .$$ 1$$. 1t helps them un!erstan! the interrelationship bet+een cost% volume% an! profit in an or#ani5ation by focusin# on interactions amon# the follo+in# five elements1. "#$. Ltd.otal fi"e! cost (.hus it is the amount available to cover fi"e! e"penses an! then to provi!e profits for the perio!.$$ " Per !nitin T . Contri(ution Margin and 1asics o CVP #nal$sis% Contri(ution margin is the amount remainin# from sales revenue after variable e"penses have been !e!ucte!. 1f the contribution mar#in is not sufficient to cover the fi"e! e"penses% then a loss occurs for the perio!.$$ )#. Prices of pro!ucts 2. /hat marketing strateg$ to emplo$. Volume or level of activity $. . 2.$$ *********** . /hat pricing polic$ to ollo/. .$$ 1#$.his concept is e"plaine! in the follo+in# e8uationsContri(ution Margin 9 -ales re*enue 2 Varia(le cost3 Contri(ution margin 2 Fixed cost3 4 5et operating Income or &oss 3or further clarification of the (asic concept o cost *olume and pro it #nal$sis !CVP anal$sis" +e no+ ta&e an e"ample. '()ecti*es o CVP #nal$sis% Cost volume profit analysis (CVP analysis) is one of the most po+erful tools that mana#ers have at their comman!. If company does not sell any more units during the period. Per unit variable cost '. /hat products to manu acture or sell.i" of pro!uct sol! 6ecause cost7volume7profit (CVP) analysis helps mana#ers un!erstan! the interrelationships amon# cost% volume% an! profit as it is consi!ere! as a vital tool in many business !ecisions.hese !ecisions inclu!e% for e"ample.

2<< an! so forth.he result +ill be e"presse! as increase in profits.. 23.$$$. .perating Profit.$$/ 3or each a!!itional unit that the company is able to sell !urin# the perio!% .$$ )#. 23.$'><<.$$ #".$$ )#.$$ *********** 1f $(2 units are sol! then +e can e"pect that net operatin# income for the perio! +ill be .. . 1f a secon! unit is sol!% for e"ample% then the total contribution mar#in +ill increase by .$$ 1$$.1$$.1<<% since the company +ill have sol! 1 unit more than the number nee!e! to brea& even. Particulars 2ales ($(1 4nit only) :ess Variable e"penses Contribution mar#in %ess &i'ed ('penses +et .2<<) an! the company=s loss +ill !ecrease by .$(%<<< in contribution mar#in% then all of the fi"e! costs +ill be covere! an! the company +ill have mana#e! to at least brea& even for the month7that is to sho+ neither profit nor loss but just cover all of its costs.o estimate the profit at any point above the brea&even point% the mana#er can simply ta&e the number of units to be sol! above the brea&even an! multiply that number by the unit contri(ution margin. Particulars 2ales ($(< 4nit only) :ess Variable e"penses Contribution mar#in %ess &i'ed ('penses +et . ) .1<< (to a total of .$$ $. . "#$.$$ 1$$.his is sho+n as follo+s by the contri(ution margin ormat income statement.3#$.$$$. ?r to estimate the effect of a planne! increase in sale on profits% the mana#er can simply multiply the increase in units sol! by the unit contribution margin.+et .#$$.$$$.%oss/ .)0.1<< in the contribution mar#in. . ?nce the brea& even point has been reache!% net income +ill increase by unit contribution mar#in by each a!!itional unit sol!.$$ 1$$.$$ 1#$. 1f enou#h units can be sol! to #enerate .$$ Per !nitin T .$$ #".#$$.$$ )#.o &no+ +hat the profit +ill be at various levels of activity% therefore% mana#er !o not nee! to prepare a +hole series of income statements.1<<% to .perating Profit.$$ *********** 5ote that the (reak e*en is the le*el o sales at /hich pro it is ZERO.his is e"plaine! by the follo+in# contribution mar#in income statement.o reach the brea& even point% the company +ill have to sell $(< units in a perio!% since each unit sol! contribute .perating Profit.4#$.$$ )#.$$ Per !nitin T . . . "#$.%oss/ Total in T . .$$ 1#$.1$$..%oss/ Total in T .he result represents the anticipate! profit for the perio!.1<< more in contribution mar#in +ill become available to help cover the fi"e! e"penses. 3or e"ample% if $(1 units are sol! !urin# the perio! then +e can e"pect that the net income for the month +ill be .

. 1.. Net Sales XXXXX Less Variable Cost XXXXX Contribution Margin XXXX Example: :etDs illustrate the di erence (et/een gross margin and contri(ution margin +ith the follo+in# information+et 9ales of T.'ed/.$$. Contri(ution Margin can be calculated as: Bet 2ales minus the variable pro!uct costs an! the variable perio! e"penses."$.ar#in Catio is the Contribution .$$$ of <ariable and T. ".$$$ of fi'ed.. 9elling and administrati<e e'penses were T.&. 0 . 5ifference between 6ross 7argin and 8ontribution 7argin: 6ross Margin is the 6ross Pro it +hich can be calculate! as+et 9ales %ess 8ost of 6oods 9old Gross Margin ::::: ::::: XXXX . 2%(<< .$$.$$$ . of unit sol! Contribution .ar#in Per 4nit Increase in the net operating income 2( @ 1<< 777 7777777777 .... 8ost of 6oods sold consisted of T. .ar#in as a percenta#e of Bet 2ales.#$. 0ach unit that is sol! re!uces the loss by the amount of the unit contri(ution margin.o illustrate it suppose company is currently sellin# '<< units an! plans to sell '2( units in near future% the anticipate! impact on profits can be calculate! as follo+s. Its in<entory of goods was the same =uantity at the beginning and at the end of year.he Contribution .he Cost of Aoo!s 2ol! consists of the fi"e! an! variable pro!uct costs% but it e"clu!es all of the sellin# an! a!ministrative e"penses. ?nce the brea& even point has been reache!% each a!!itional unit sol! increases the company=s profit by the amount of the unit contribution mar#in. 1.o summari5e these e"amples% if there +ere no sales% the company=s loss +oul! e8ual to its ixed expenses.$$$ during the past year.$$$ . 1ncrease! no. 0$.<ariable/ and T.

87 >atio/which can be calculated as: CM Ratio = Contribution Margin / Sales This ratio is e'tensi<ely used in cost*<olume profit calculations. $2<%<<< .=>.::: .<.ar#in Catio is =?.&.$$.$$$.&. "#$.&.2><%<<< !ivi!e! by .''<%<<< !ivi!e! by . 1..&. 12<%<<< A!ministrative .anufacturin#.$$$.$$$.&.$$ 0$.he Aross .he Contribution .)<<%<<<% or . )<<%<<< :ess Variable 0"penses. +he compan$7s Contri(ution Margin isBet 2ales .?> (.$$$.&.$$ 1#$.&.%oss/ Total in T .. 89:. '<%<<< .&.ar#in or Aross Profit Percenta#e is the Aross Profit of .::: . )<<%<<< .$ $ 4$.$$ *********** Percentage of 9ales 1$$ 4$ 0$ Contribution .$$ )#.$$ #.$$$. Contri(ution Margin @atio !CM @atio"% The contribution mar#in as a percentage of sales is referred to as contribution margin ratio . 1)<%<<< Contri(ution Margin . Particulars 2ales ('<< 4nits only) :ess Variable e"penses Contribution mar#in %ess &i'ed ('penses +et .ar#in Catio 9 ( '<%<<< / 1<<%<<<) E 1<< 9 '<F # .&.+he compan$7s 6ross Margin is% Bet 2ales :ess Cost of Aoo!s 2ol!Variable . .perating Profit. 12<%<<< 3i"e! .)<<%<<<). 2<<%<<< 6ross Margin .$$ Per !nit in T .:.$$ 1$$.&.

Importance of Contribution Margin Ratio: .he CVP concept can be use! in plannin# an! !ecision ma&in#.o illustrate% notice that M/s ABC Co.<< '<%<<<.1 sales E C. td has a C. .his means that for each !ollar increase in sales% total contribution mar#in +ill increase by '< cents (.$<%<<< increase! sales E C.12%<<< if fi"e! cost !o not chan#e.<< $(%<<<. ratio of '<F).otal in .G. We shall use these concepts to sho+ ho+ chan#es in variable costs% fi"e! costs% sales price% an! sales volume affect contribution mar#in an! profitability of companies in a variety of situations. 1%<<%<<<.1*%<<< can also be calculate! !irectly by usin# the follo+in# formulaAP34 !-ales B CM ratio" C Fixed CostD #pplications o Cost Volume Pro it !CVP" #nal$sis% . .he C.<< 12%<<<. . ratio is such an important tools +hich helps to sho+s ho+ the contribution mar#in +ill be affecte! by a chan#e in total sales. As +e note! above% Bet operatin# income +ill also increase by .<< 1ncrease $<%<<<.his is verifie! by the follo+in# tableParticulars 2ales ('<< 4nits only) :ess Variable e"penses Contribution mar#in :ess 3i"e! 0"penses Bet ?peratin# Profit/ (:oss) . 3or e"ample if the M/s ABC Co.<< (%<<<. • • • • • Chan#e in fi"e! cost an! sales volume Chan#e in variable cost an! sales volume Chan#e in fi"e! cost% sales price an! sales volume Chan#e in variable cost% fi"e! cost% an! sales volume Chan#e in re#ular sales price 4 .<< 1*%<<<.12%<<< (.<< 12%<<<.<< 0"pecte! 2ales in .$<%<<< increase in sales !urin# the comin# month% the contribution mar#in shoul! increase by . Bet operatin# income +ill also increase by '< cents% assumin# that fi"e! cost !o not chan#e. ratio of '<F.<< (2%<<<. ratio of '<F). 1$<%<<<.<< )<%<<<. The impact on net operating income of any given dollar change in total sales can be computed in seconds by simply applying the contribution margin ratio to the dollar change.G. td plans a .<< *>%<<<.<< 1>%<<<.<< $(%<<<.<< <.<< Percenta#e of 2ales )< '< H0"pecte! net operatin# income of .

Cost Volume Pro it !CVP" @elationship in 6raphic Form% .1reak E*en point% 1reak e*en point is the level of sales at +hich profit is 5ero.he relationships amon# revenue% cost% profit an! volume can be e"presse! #raphically by preparin# a costF*olumeFpro it !CVP" graph or (reak e*en chart. Preparin# a CVP #raph involves three steps. E!uation Met"od: . 3 . . Preparing a CVP 6raph or 1reakFE*en Chart% 1n a CVP #raph some times calle! a brea& even chart unit volume is commonly represente! on the hori5ontal (@) a"is an! !ollars on the vertical (I) a"is.he format of this statement can be e"presse! in e8uation form as follo+sAPro it 4 !-ales 2 Varia(le expenses" 2 Fixed expensesD Cearran#in# this e8uation sli#htly yiel!s the follo+in# e8uation% +hich is +i!ely use! in cost volume profit (CVP) analysisA-ales 4 Varia(le expenses E Fixed expenses E Pro itD Accor!in# to the !efinition of brea& even point% brea& even point is the level of sales +here profits are 5ero. A CVP #raph hi#hli#hts CVP relationships over +i!e ran#es of activity an! can #ive mana#ers a perspective that can be obtaine! in no other +ay. Accor!in# to this !efinition% at break even point sales are e8ual to ixed cost plus *aria(le cost. . . .he e0uation method centers on the contribution approach to the income statement.he brea& even point can be calculate! usin# either the e0uation method or contri(ution margin method.herefore the brea& even point can be compute! by fin!in# that point +here sales just e8ual the total of the variable e"penses plus fi"e! e"penses an! profit is 5ero.his concept is further e"plaine! by the follo+in# e8uation1reak e*en sales 4 ixed cost E *aria(le cost .hese t+o metho!s are e8uivalent.

• • • 2ales price per unit 9 . 1(<.<< .otal fi"e! e"penses 9 .he brea& even point in sales !ollars can be compute! by multiplyin# the brea& even level of unit sales by the sellin# price per unit. $(%<<<.<< Calculate break even point Calculation% !" in Sales = Variable expenses # Fixed expenses $%&' = (%&' # )%*&&& (&&' = )%*&&& ' = )%& +nits .>*%(<< 2 . 2(<.2(< Per unit 9 .3or example +e can use the follo+in# !ata to calculate brea& even point. $(< 4nits E .<< variable cost per unit 9 .

. -ales"D 1 .$(%<<< / <.ar#in ratio (C. 6rea& even point in units 9 3i"e! e"penses / 4nit contribution mar#in . +he ollo/ing ormula is also used to calculate (reak e*en point 1reak E*en -ales in Dollars 4 AFixed Cost .he contribution mar#in metho! is actually just a short cut conversion of the e8uation metho! alrea!y !escribe!.o fin! out ho+ many units must be sol! to brea& even% !ivi!e the total fi"e! cost by the unit contribution mar#in. 6rea& even point in total sales !ollars 9 3i"e! e"penses / C.) A variation of this metho! uses the Contribution .his approach is particularly suitable in situations +here a company has multiple pro!ucts lines an! +ishes to compute a sin#le brea& even point for the company as a +hole.'< 9 .Contribution Margin Met"od: .>*%(<< .1(< (Variable e"p.1<<H per unit $(< 4nits H22(< (2ales) J . .he approach centers on the i!ea !iscusse! earlier that each unit sol! provi!es a certain amount of contribution mar#in that #oes to+ar! coverin# fi"e! cost. ratio . ratio) instea! of the unit contribution mar#in. .$(%<<< / . G C !Varia(le Cost .he result is the brea& even in total sales !ollars rather than in total units sol!.

$(%<<< / <. Costs are linear an! can be accurately !ivi!e! into variable an! fi"e! elements. 1f operatin# levera#e is hi#h% a small percenta#e increase in sales can pro!uce a much lar#er percenta#e increase in net operatin# income. 2ellin# price is constant. 1$ . An or#ani5ation often has some latitu!e in tra!in# off bet+een these t+o types of costs. ?peratin# levera#e acts as a multiplier.' 9 . .. While some of these assumptions may be violate! in practice% the violations are usually not serious enou#h to call into 8uestion the basic vali!ity of CVP analysis. 8. 'perating &e*erage and degree o operating le*erage% ?peratin# levera#e is a measure of ho+ sensitive net operatin# income is to percenta#e chan#es in sales.) 9 .he purpose of mana#ement is to re!uce the cost by choosin# a blen! of fi"e! an! variable cost that ma"imi5es the ultimate objective i. 2. 3or e"ample% fi"e! investment in automate! e8uipment can re!uce variable labor costs.e. (.N profit. . 1n multi7pro!uct companies% the sales mi" is constant.he price of a pro!uct or service +ill not chan#e as volume chan#es. #ssumptions o Cost Volume Pro it !CVP" #nal$sis% A number of assumptions un!erlie cost7volume7profit (CVP) analysis.he variable element is constant per unit% an! the fi"e! element is constant in total over the relevant ran#e..hese cost *olume pro it anal$sis assumptions are as follo+s1.>*%(<< Cost Volume Pro it !CVP" Consideration in Choosing a Cost -tructure% Cost structure refers to the relative proportion of fi"e! an! variable costs in an or#ani5ation.he number of units pro!uce! e8uals the number of units sol!.his formula can pro!uce the same ans+er6rea& 0ven Point 9 K.$(%<<< / 1 L (1(< / 2(<)M 9 . 3or e"ample% in most multi7pro!uct companies% the sales mi" is constant enou#h so that the result of CVP analysis are reasonably vali!. '. 1n manufacturin# companies% inventories !o not chan#e. . ).$(%<<< / 1 L <. .

&imitations o Cost Volume Pro it #nal$sis% i. ii. 1t may be !ifficult to classify a cost as all variable or all fi"e!N an! there may be a ten!ency to continue to use a brea& even analysis after the cost an! income functions have chan#e!. Cost volume profit (CVP) is a short run% marginal analysis% not so much useful for lon# turn analysis. iii. .he CVP analysis reco#ni5es that the avera#e variable cost per unit +ill remain the same all over the operational sta#es but in practice !ue to the e"istence of purchase !iscount% the unit variable cost varies in !ifferent levels of operation.he main ad*antages o (reake*en point anal$sis are that it e"plains the relationship bet+een cost% pro!uction% volume an! returns. 6rea& even analysis is most useful +hen use! +ith partial bu!#etin#% capital bu!#etin# techni8ues. 1ene its .<. 1n case of multi7pro!uct companies% it is assume! that the sales mi" is constant but it may sel!om happen. #d*antages o 1reak E*en #nal$sis% . 1t can be e"ten!e! to sho+ ho+ chan#es in fi"e! cost% variable cost% commo!ity prices% an! revenues +ill affect profit levels an! brea& even points.he major (ene its to use brea& even analysis are that it in!icates the lo+est amount of business activity necessary to prevent losses.he CVP analysis reco#ni5es that the unit sales price +ill remain the same all over the operational sta#es an! it !oes not reco#ni5es the amount of sales !iscount !epen!in# on the volume of sales. v. 1n case of manufacturin# companiesD% it is e"pecte! to have the same amount of inventories at the be#innin# an! en!in# of the perio! but in practice% it is so !ifficult to maintain the same inventory level at the be#innin# an! en!in# of the perio!. vi. 1t is best suite! to the analysis of one pro!uct at a time. iv. 11 . . =. . OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO.

$$$.Md. 3$. e<en Point.$$ condition. #. #$. 14.$$$.$$ +ow. Eow the ?(P changes when the fi'ed cost rises to T. the management is e'pecting the &ollowing: Per !nit 9ales Price is T. ?rea. 20.... %td. After analy@ing the present mar.. can sale "#$$ unit D t. 8ontribution 7argin Per !nit & what does it meanB ". If the &i'ed 8ost >emains the same at T.. 0". 3. is planning to add one new product with their e'isting product line. 8ontribution 7argin >atio. 02.e a profit of T. 3$..$$ per unit..%oss position when the co. 20. and the <ariable cost rises to T. Chat will be the Profit. ).now the following Information: 1.$$ per unit. Eow many units needs to be sold if the management wants to ma.$$. Exercise H G The A?8 8o.$$ &i'ed 8ost T. the management wants to . Jaker Hossain Joint Director Foreign E change !nspection " #igilance Department.$$$.$$ Per !nit Aariable cost T. 0.$$$. 4. 1" . before starting the operation.$$.

$$$.$$ ***************** +et . "2.. 3$..$$ per unit means per additional unit sales will reduce the &i'ed 8ost by T.$$ %ess Total Aariable 8ost D T. in units/ ?(P .8-7 >atio F 20.$$ F 1. The status of the co..$$$. Chat will happen when the sales price per unit rises to T.$$ per unitB 2olution @e0uirement H G 9ales per !nit Aariable 8ost Per !nit T.perating %oss .$$ per unit operating Profit after e'ceeding the ?(P.10. @e0uirement H ."2 F )$$$ units &i'ed 8ost .$$ 8-7 T. "2. 0". 3#.::" I G:: 4 .. will be in ?(P...=:.1$.$$ F 1. Per 4nit / 2ales Per 4nit !89.$$ per !nit F "#$$:3$...$$ T.$$ *************** 8ontribution 7argin Per !nit: T. can sale )$$$ units or T..2.3#. Catio 9 C/..$$.$$$.8-7 per unit F 20.$$ The abo<e information means that if the co. 3$. @e0uirement H 8 C/. "2.1$..$$ %es &i'ed 8ost 20.$$$.::.$$$.$$.$$$.$$$-0$G F ". "2. ".$$/ 1) .$$ F "#$$:0". Total 9ale "#$$ units D t.:> @e0uirement H ? ?(P .$$$.$$ before the ?(P and will generate T./ &i'ed 8ost.$$$. 0".$#.$$ **************** 6ross 8ontribution 7argin 3$.

$$ /F "1.) +ill be3i"e! Cost/ C. 20. 02.$$ +ew 87 >atio 00G 10 .$$$.@e0uirement H J >e=uired le<el of Production in units will be : units >e=uired le<el of sales in T.&.$$$/..$$$ units And +ew ?(P in T. new ?(P in units will be : 20. )..)#.$$ F 032# @e0uirement H < When 3i"e! cost rises to .he ne+ 60P sales (in units) +ill be.<< 9 $'2P units An! 60P sales (in .$$$.$$$.. &i'ed 8ost H >e=uired Profit/-8-7 per !nit. 3#."2.20$$$ H #$.$$*01.. F .$$$-)$. &i'ed 8ost H >e=uired Profit/-8-7 >atio F .20$$$ H #$.2$.$$ per unit +ew 87 will be T.<<% .$$ @e0uirement H 9 Chat will happen when the sales price per unit rises to T.$$.$$ F ".$$$.3$.will be: .$$$.$$$. Cill be : 20.&.$$ ..$$ +ew ?(P in units will be: *************************** F ********************* F "#04 units +ew 87 per !nit )) +ew ?(P in T. and the <ariable cost rises to T. will be: &i'ed 8ost 20.$$ 9o.<</'<F 9 2%'<%<<<.$$ per unitB &i'ed 8ost 20.. ratio 9 P)<<<.$$$/-0$G F T. P)%<<<.3i"e! Cost/ C.. per unit 9 P)<<</2>.<< @e0uirement H = If the &i'ed 8ost >emains the same at T.$$ *********************** F ***************** F 11$1$$..$$-"1 F 0. .

1# .