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CVP ANALYSIS

INTRODUCTION
Cost-Volume-Profit analysis is a planning tool which is extremely
useful in predicting sales and profit levels given a certain cost structure.
Traditional CVP analysis has been applied largely to manufacturing
enterprises which have a tangible product base (e.g., furniture). However,
the concept itself is applicable to service enterprises such as banking,
insurance and other financial service industries. This paper will outline the
basic CVP model and thereafter demonstrate its applicability and related
complexities to the banking sector.

CVP ANALYSIS
CVP stands for Cost-Volume-Profit. The CVP analysis is a financial
decision making aid used to determine the level of output used to achieve
any target profit level or the financial impact of basic business activities like
changes in costs or pricing.
Dutch- Rural Novo
Bangla Tabani- Electrification Pharmaceuticals, NCC Bank
Companies Name Bank, Palli Board Intra Ent.
Bidyut
Bevarage Ltd.
samity-1
Servic Non-Profit Merchandisin Financi
Nature MNC
e g al
Yes Yes
CVP Analysis No Yes No
Break even Yes Yes
No Yes No
quantity
No Yes Yes
Target Profit No Yes

Margin of No Yes Yes


No Yes
Safety
Degree of No Yes Yes
operating No Yes
Leverage
Sensitivity No Yes Yes
No Yes
Analysis
Probabilistic No Yes Yes
break-even No Yes
analysis 1
THE BASIC COST-VOLUME-PROFIT MODEL
1. The behavior of costs and revenues is linear.

2. Selling prices are constant.

3. All costs can be divided into their fixed and variable elements.

4. Total fixed costs remain constant.

5. Total variable costs are proportional to volume.

6. Prices of production inputs (e.g., materials) are constant.

7. Efficiency and productivity are constant.

8. The analysis covers a single product or a constant sales mix.

9. Revenue and costs are being compared over a single volume base (e.g.,
units).

10. Volume is the only driver of costs.

Method Applied

The Equation Method:

The Equation Method centers on the contribution approach to


the income statement. The format of this income statement can be
expressed form as follows:

Profit = (Sales – Variable expenses)- Fixed expenses

Rearranging this equation slightly yields the following equation,


which is widely used in CVP analysis:

Sales = Variable expenses + Fixed expenses + Profit

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The contribution Margin Method:

The contribution margin method is just shortcut version of the


equation method. Each unit sold provides a certain amount of
contribution margin that goes toward covering fixed costs.

Break- even point in unit sod= fixed expenses/unit contribution


margin.

Break- even point in unit sold = Fixed expenses / CM ratio

The graphical method:

In this method CVP analysis is shown by graphically. From that a


company can easily identify it’s present and future condition.

Main tools
The main tools used for a CVP analysis are:

1.Break even quantity


The break-even point for a product is the point where total revenue received
equals the total costs associated with the sale of the product (TR=TC). [1]A
break-even point is typically calculated in order for businesses to determine
if it would be profitable to sell a proposed product, as opposed to attempting
to modify an existing product instead so it can be made lucrative. Break-
Even Analysis can also be used to analyse the potential profitability of an
expenditure in a sales-based business.

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YES
Break-even Quantity
Break Even
50% 50%
Quaqntity
45%
40% 2. Target Profit
40%
35%
30%
30%
20% CVP formulas can be used to
25%
20%
10% determine the sales volume needed
15%
10%
0% to achieve a target profit.
5%
0%

Equation:

Total sales quantity = Fixed cost + Target


profit /unit contribution margin

YES NO

50% 50%
40% 40%
30% Target of 30% Target of
20% Profit 20% Profit

10% 10%
0% 0%

3. Margin of Safety
The margin of safety is the excess of budgeted sales dollars over break- even
volume of sales dollars. It states the amount by which sales can drop before
losses are incurred. The higher the margin of safety, the lower the risk of not
breaking even.

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The formula for calculation:

Total budgeted sales – Break- even sales

The margin of safety can also be expressed in percentage form by dividing


the margin of safety in dollars by total sales:

Margin of safety percentage:

Margin of safety in dollars/ Total budgeted sales

In break-even analysis, margin of safety is how much output or sales level


can fall before a business reaches its break-even point (BEP).

Margin of safety = ((Budgeted sales - break-even


sales) /Budgeted sales) x 100%

YES NO

50% 50%
40% 40%
30% Margin of 30% Margin of
20% safety 20% safety

10% 10%
0% 0%

4. Degree of operating Leverage


To which extent a business uses fixed costs in operations. With help of
breakeven points the organization can examine the effects of increases or
decreases in fixed costs.

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The Degree of Operating Leverage (DOL) can be computed in a number of
equivalent ways; one way it is defined as the ratio of the percentage change
in Operating Income for a given percentage change in Sales

YES

NO
70.00%
60.00%
40.00%
50.00%
40.00% Degree of
30.00%
operating
30.00%
Leverage 20.00% Degree of
20.00% operating
10.00% 10.00% Leverage
0.00%
0.00%

5. Sensitivity Analysis:
Sensitivity analysis (SA) is the study of how the variation (uncertainty) in
the output of a mathematical model can be apportioned, qualitatively or
quantitatively, to different sources of variation in the input of a model.[1]".

In more general terms uncertainty and sensitivity analyses investigate the


robustness of a study when the study includes some form of mathematical
modelling. While uncertainty analysis studies the overall uncertainty in the
conclusions of the study, sensitivity analysis tries to identify what source of
uncertainty weights more on the study's conclusions. For example, several
guidelines for modelling (see e.g. one from the US EPA) or for impact
assessment (see one from the European Commission) prescribe sensitivity
analysis as a tool to ensure the quality of the modelling/assessment.

The problem setting in sensitivity analysis has strong similarities with


Design of experiments. In design of experiments one studies the effect of
some process or intervention (the 'treatment') on some objects (the
'experimental units'). In sensitivity analysis one looks at the effect of varying
the inputs of a mathematical model on the output of the model itself. In both
disciplines one strives to obtain information from the system with a
minimum of physical or numerical experiments.

Sensitivity Analysis can be used to determine:

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1. The model resemblance with the process under study
2. The quality of model definition
3. Factors that mostly contribute to the output variability
4. The region in the space of input factors for which the model variation
is maximum
5. Optimal - or instability - regions within the space of factors for use in
a subsequent calibration study
6. Interactions between factors

Sensitivity Analysis is popular in financial applications, risk analysis, signal


processing, neural networks and any area where models are developed.

YES NO

70.00%
35.00%
60.00% 30.00%
50.00% 25.00%

40.00% 20.00%
Sensitivity Sensitivity
Analysis 15.00% Analysis
30.00%
10.00%
20.00%
5.00%
10.00%
0.00%
0.00%

NATURE OF ORGANIZATION

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1. Service company:
Service (also known as Client Service) is the provision of service to
customers before, during and after a purchase. Service is a series of
activities designed to enhance the level of customer satisfaction. Its
importance varies by product, industry and customer. As an example,
an expert customer might require less pre-purchase service (i.e., advice)
than a novice. In many cases, service is more important if the purchase
relates to a “service” as opposed to a “product".

service may be provided by a person (e.g., sales and service


representative), or by automated means called self-service

2. Financial company:
An entity whose income exceeds its expenditure can lend or invest the
excess income. On the other hand, an entity whose income is less than
its expenditure can raise capital by borrowing or selling equity claims,
decreasing its expenses, or increasing its income. The lender can find a
borrower, a financial intermediary such as a bank, or buy notes or
bonds in the bond maket. The lender receives interest, the borrower
pays a higher interest than the lender receives, and the financial
intermediary pockets the difference.

Finance is one of the most important aspects of business management.


Without proper financial planning a new enterprise is unlikely to be
successful. Managing money (a liquid asset) is essential to ensure a
secure future, both for the individual and an organization.

3. Multinational Company:

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Multinationals have played an important role in globaliztion. Countries
and sometimes subnational regions must compete against one another
for the establishment of MNC facilities, and the subsequent
tax,revenue, employment, and economic activity.

Many MNCs are large in relation to the national income of the


countries in which they are located. This means that it is not as easy for
the host governments to enforce national laws on MNCs. Generally
speaking, governments want investment from these MNCs because
they generate jobs and incomes. Other benefits include training of local
workers in new and potentially transferrable skills.

4. Non – Profit company:

Non – Profit companies are that which dose not get any profit but hey
take off their expenses. Their cost and revenue re same. In case of
Bangldesh, in non – profit orgnization like NGO

5. Merchandising company:
Goods and commodities sold at the retail level. Merchandising is the
buying, presenting, and selling of merchandise. This includes all
the related activities of advertising, displaying, and promoting
merchandise to the retail customer

Limitations:
CVP is a short run, marginal analysis: it assumes that unit variable costs and
unit revenues are constant, which is appropriate for small deviations
from current production and sales, and assumes a neat division between
fixed costs and variable costs, though in the long run all costs are
variable. For longer-term analysis that considers the entire life-cycle of
a product, one therefore often prefers activity-based costing or
throughput accounting.[2]

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Limitation of companies CVP analysis:
1. Lack of technical knowledge.
2. Lack of enough staff.
3. In case of service provider all elements are not available for analyzing.
4. Lack of government rules and regulatory.
5. Lack of efficient manpower.
6. Leader conflict between accountant and leading department.
7. In case of inflation of economy.
8. In case of foreign exchange.
9. Lack of modern technology.

How to minimize limitation:


1. Need to train up traditional accounting people.
2. Support of software.
3. Government should establish acceptable rules and regulation.
4. Company should appoint more efficient manpower.
5. Company should be established rules and regulation to minimize leadership and
accountant conflict.
6. Remove economic inflation.
7. Analyzing previous data

Summary:
Cost- Volume- Profit (CVP) analysis is one of the most powerful tools that managers
have at their command. It helps them understand the relationships among cost, volume,
and profit by focusing on interactions among the following five elements:
1.Prices of the product
2.volume or level of activity
3. Per unit variable cost
4.Total fixed cost
5.Mix of product sold.

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Bibliography

• Cacuci, Dan G., Mihaela Ionescu-Bujor, Michael Navon, 2005,


Sensitivity And Uncertainty Analysis: Applications to Large-Scale
Systems (Volume II), Chapman & Hall.
• Fassò A. (2007) Statistical sensitivity analysis and water quality. In
Wymer L. Ed, Statistical Framework for Water Quality Criteria and
Monitoring. Wiley, New York.
• Fassò A., Esposito E., Porcu E., Reverberi A.P., Vegliò F. (2003)
Statistical Sensitivity Analysis of Packed Column Reactors for
Contaminated Wastewater. Environmetrics. Vol. 14, n.8, 743 - 759.
• Fassò A., Perri P.F. (2002) Sensitivity Analysis. In Abdel H. El-
Shaarawi and Walter W. Piegorsch (eds) Encyclopedia of
Environmetrics, Volume 4, pp 1968–1982, Wiley.
• J.C. Helton, J.D. Johnson, C.J. Salaberry, and C.B. Storlie, 2006,
Survey of sampling based methods for uncertainty and sensitivity
analysis. Reliability Engineering and System Safety, 91:1175-1209.

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