Topic 4:

CostVolumeProfit analysis

AnaMAriasAlvarez

UniversityofOviedo
DepartmentofAccounting
amarias@uniovi.es

SchoolofBusinessAdministration
Course:FinancialStatementAnalysisandManagementControl
BachelorsDegreeinEconomics

AnaMAriasAlvarez (University ofOviedo) CostVolumeProfit analysis OpenCourseWare

 4.1. CostVolumeProfit assumptions.
4.2. Breakeven point.
4.3. Margin of safety. Sensitivity analysys.
4.4. Multiproduct CostVolumeProfit analysis.

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 4.1: COSTVOLUMEPROFIT ASSUMPTIONS.

CostVolumeProfit analysis (CVP analysis) is based on the relationship between

volume and sales revenue, costs and profit in the short run (one year or less).

CVP analysis is useful for guiding decisions:

Calculating the units that need to be sold to achieve a target profit.
Effect on profits if we change our selling price.
Effect on profits if we change our product mix.

3/18 AnaMAriasAlvarez (University ofOviedo) CostVolumeProfit analysis OpenCourseWare

 CostVolumeProfit analysis assumptions
1. Total costs can be separated into two components: fixed costs and variable costs.
2. Selling price is known and constant.
3. Fixed costs are known and constant.
4. No increase in efficiency occurs in the period of activity studied.
5. Unit variable costs remain the same and there is a direct relationship between cost
and volume.
6. Volume is assumed to be the only important factor affecting cost behaviour.
7. Inventory changes are insignificant.

4/18 AnaMAriasAlvarez (University ofOviedo) CostVolumeProfit analysis OpenCourseWare

 4.2: BREAKEVEN POINT.

Quantity of output sold at which total revenues equal total costs,

that is, the quantity of output sold that results in 0 of profit.

Profit=Salesrevenue Totalcosts=
=(px Q) FC (vcx Q)=
=(p vc)x Q FC
p:sellingpriceperunit
Q:numberofunits
FC:totalfixedcosts
vc:variablecostperunit

5/18 AnaMAriasAlvarez (University ofOviedo) CostVolumeProfit analysis OpenCourseWare

 The breakeven point is achieved when we have obtained
sufficient totalcontribution tocover totalcosts:

Profit=(p vc)x Q FC=0

FC
Breakevenpointinunits=
p vc

Contributionperunit

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 Breakevenpointineuros:

FCx p FC FC
= = vc
p vc p vc 1
p p
Contributionmarginratio
(CMR) Variablecostratio
(VCR)

Notethat CMR+VCR=1

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 Breakevenchart

Profitarea

Breakevenpoint
0
Q
Lossarea Unitsofproductionandsales

FC

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 Unitstobesoldtoobtainatargetprofit:

Targetprofit=TP=(p vc)x Q FC
(p vc)x Q=FC+TP

FC+TP
Q =
p vc

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 Targetprofitexpressedasapercentageofsales(a):

Targetprofit =ax px Q=(p vc)x Q FC

(p vc ax p)x Q=FC
FC
Q =
p vc ax p

10/18 AnaMAriasAlvarez (University ofOviedo) CostVolumeProfit analysis OpenCourseWare

 4.3: MARGIN OF SAFETY. SENSITIVITY ANALYSIS.

Themarginofsafetyindicatesbyhowmuchsalesmay
decreasebeforealossoccurs:

Margin ofsafety=Expected sales Breakeven sales

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 Alternatively, we can express the margin of safety in a
percentage form based on the following ratio:

Expected sales Breakeven sales

Percentage =
marginofsafety Expected sales

Margin of safety is a mechanical way of saying whether a

company is close to the breakeven point.

12/18 AnaMAriasAlvarez (University ofOviedo) CostVolumeProfit analysis OpenCourseWare

 Used with the Contribution margin ratio(CMR),the Percentage
margin ofsafetyratiodeterminesthe percentage ofsalesthat
profit represents:

(PercentagemarginofsafetyxContributionmarginratio)x
Expectedsales=Expectedprofit

13/18 AnaMAriasAlvarez (University ofOviedo) CostVolumeProfit analysis OpenCourseWare

 4.4: MULTIPRODUCT COSTVOLUMEPROFIT ANALYSIS.

1) Sales mix effect on Breakeven point.

2) Retail company: a markup is added to cost price to get the

selling price.

3) Retail company: different departments with different mark

ups.

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 1) SalesmixeffectonBreakevenpoint:

FC
Total
Break even=
Weightedaveragebudgetedcontributionmargin
point

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 Task: try to solve problem 4.1.

16/18 AnaMAriasAlvarez (University ofOviedo) CostVolumeProfit analysis OpenCourseWare

 2)Retailcompany:amarkupisaddedtocostpricetogetthe
sellingprice

Let mbethe markupadded tocost price toget the selling price:

p=vc+vcx m=vcx (1+m)

Breakeven FCx p FCx vcx (1+m)

point = = =
p vc vcx (1+m) vc
inEuros
FCx (1+m)
=
m

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 3)Retailcompany:differentdepartmentswithdifferentmarkups

Breakeven FC
pointin = Weightedaverage budgeted Contribution margin ratio
=
Euros
FC
=
CMRi x Salesi
i Totalsales

18/18 AnaMAriasAlvarez (University ofOviedo) CostVolumeProfit analysis OpenCourseWare