Example No.

1:
Total Per unit
Sale (400 Speakers) 100,000 250
Less: Variable Cost (60,000) (150)
Contribution Margin 40,000 100
Less: Fixed Cost (35,000)
Net Operating Income 5,000

Explaination of change in activity affect Contribution Margin & Net Operating Income:

On Sale of 1 Speaker:
Total Per unit
Sale (1 Speaker) 250 250
Less: Variable Cost (150) (150)
Contribution Margin 100 100
Less: Fixed Cost (35,000)
Net Operating Loss (34,900)
On Sale of 2 Speakers:
Total Per unit
Sale (2 Speakers) 500 250
Less: Variable Cost (300) (150)
Contribution Margin 200 100
Less: Fixed Cost (35,000)
Net Operating Loss (34,800)

On Sale of 350 Speakers:

Total Per unit
Sale (350 Speakers) 87,500 250
Less: Variable Cost (52,500) (150)
Contribution Margin 35,000 100
Less: Fixed Cost (35,000)
Net Operating Income -

On Sale of 351 Speakers:

Total Per unit
Sale (351 Speakers) 87,750 250
Less: Variable Cost (52,650) (150)
Contribution Margin 35,100 100
Less: Fixed Cost (35,000)
Net Operating Income 100

Increased in numbers of speakers sold 25

Contribution margin per speaker x $ 100
Increase in Net Operating Income 2,500
CONTRIBUTION MARGIN RATIO:

C. M. Ratio = TotalContribution Margin 40,000 40%

Total Sales 100,000

Or: C. M. Ratio = Contribution Margin Per unit 100 40%

Sales price Per unit 250

Impact on Net Operating Income on changes in Sales, by C.M. ratio:

Calculation of changes in net income, with the changes in sales, without I/S
Increase in Sales 30,000
C.M. ratio 40%

Increase in Net operating Income 12,000

Proof: Present Expected Changes Percentage

Sales 100,000 130,000 30,000 100%
Less: Variable Cost (60,000) (78,000) (18,000) 60%
Contribution Margin 40,000 52,000 12,000 40%

Less: Fixed Cost (35,000) (35,000) -

Net Operating Income 5,000 17,000 12,000

Some Applications of CVP Analysis:

Consider the following example:

 Selling Price per unit 250
Variable Cost per unit 150
C. M. (in amount) 100
C.M. Ratio 40%
Fixed Cost 35,000 per month.
Current Sales (in units) 400

Concept No.1: (Change in Fixed Cost and Sales Volume):

Sales manager feels that by increase in $10,000 fixed cost i.e, advertising budget,
then the sale will increase by $30,000 to a total 520 units. Should the advertising
budget increase,
Total Method:
1 Current C. Margin ($100,000 x 40%) = 40,000
Proposed C. Margin ($ 130,000 x 40%) = 52,000
Increase in CM 12,000
Increase in FC 10,000
Increase in Income 2,000

2 Current C. Margin (400 Speakers x $100) 40,000

Proposed C. Margin (520 Speakers x $100) 52,000
Increase in CM 12,000
Increase in FC 10,000
Increase in Income 2,000
Incremental Method:
3 Increase in C. M (30,000 x 40%) = 12,000
Increase in FC 10,000
Increase in Income 2,000

4 Increase in C. M (120 Speakers x $100) 12,000

Increase in FC 10,000
Increase in Income 2,000
 OR

Proof: Present Expected Changes Percentage

Sales 100,000 130,000 30,000 100%

Less: Variable Cost (60,000) (78,000) (18,000) 60%

Contribution Margin 40,000 52,000 12,000 40%

Less: Fixed Cost (35,000) (45,000) (10,000)

Net Operating Income 5,000 7,000 2,000

Concept No.2: (Change in Variable Cost and Sales Volume):

 Management consider to change the part with more high quality part. Sale 250
This will increase the variable cost by $10 which decrease the VC (160)
contribution margin by $ 10. It increases the sales to 480 speakers. CM 90
Should this changes incorporated:
CM ratio = 90
Current C. Margin = ($100,000 x 40%) = 40,000 250
Proposed C. Margin = (480 x 250 = $120,000 x 36%) = 43,200 36%
Increase in C.Margin / Income 3,200

Current C. Margin = (400 speakers x $100) = 40,000

Proposed C. Margin = (480 Speakers x $ 90) = 43,200
Increase in C.Margin / Income 3,200

Method #1:
Current C. Margin
 ($100,000 x 40%) 40,000
Expected C. Margin CM Ratio = C. M. 90 36.00%
(480 Speakers x $ 250 = 120,000) Sales 250
($120,000 x 36%) 43,200
Increase in C. Margin 3,200 Method # 2:
Current C. Margin
(400 Speakers x $ 100) 40,000
Expected C. Margin
(480 speakers x $90) 43,200
Increase in C. Margin 3,200

1 Expected Contribution Margin

(480 speakers x $ 90) 43,200
2 Current Contribution Margin
(400 speakers x $ 100) 40,000
Increase in Contribution margin 3,200

1 Expected Contribution Margin CM Ratio =

(480 speakers x $ 250 = $120,000 x 36% 43,200 90
2 Current Contribution Margin 250
(400 speakers x $ 250 = $100,000 x 40% 40,000 36%
Increase in Contribution margin 3,200
Concept No.3: (Change in Fixed Cost, Sales Price and Sales Volume):
Assumption:
Management consider to cut the selling price by $20 per speaker,
increases fixed cost by $15,000 in advertising budget per month,
these changes increases the sales by 50% i.e. 600 speakers.
Should this changes incorporated:

Current C. Margin = ($100,000 x 40%) = 40,000

Proposed C. Margin = (600 speakers x $230 = $138,000 x 34.78%) = 48,000 CM ratio = 80 34.78%
Increase in C. Margin 8,000 230
Increase in FC 15,000
Decrease in Income 7,000

Current C. Margin = (400 Speakers x $100) = 40,000

Proposed C. Margin = (600 Speakers x $ 80) = 48,000
Increase in C. Margin 8,000
Increase in FC 15,000
 Decrease in Income 7,000

Sales (600 Speakers x $ 230) 138,000

Less: Variable Cost (600 Speakers x $ 150) (90,000)
Contribution Margin 48,000
Less: F. Cost (50,000)
Net Loss (2,000)

Concept No.4: (Change in Variable Cost, Fixed Cost and Sales Volume):
Assumption:
Management decided to pay $15 per speaker commission to
Sales person and stop payment of $6,000 fixed amount of
salaries, this change will increase the monthly sales by 15%
i.e. to 400 speakers to 460 speakers per month.
Should this changes incorporated:

Current C. Margin = ($100,000 x 40%) = 40,000

Proposed C. Margin = (460 x $250 = 115,000 x 34%) 39,100 CM ratio = 85 34%
Decrease in CM 900 250
 Decrease in FC 6,000
Increase in Income 5,100

Current C. Margin = (400 speakers x $ 100) = 40,000

Proposed C. Margin = (460 speakers x $ 85) = 39,100
Decrease in CM 900
Decrease in FC 6,000
Increase in Income 5,100

Concept No.5: (Change in Variable Cost, Fixed Cost and Sales Volume):
Management decided to reduce the sales price by $ 15, Use of good quality part which increase the
Variable cost by $ 5, also decided to increase the fixed cost i.e $ 20,000 which increase the sales
volume by 100 speakers

Current C. Margin = ($100,000 x 40%) = 40,000

Proposed C. Margin = (500x $ 235 = $117,500 x 34.04%) 40,000 CM ratio = 80 34.04%
Decrease in CM - 235
Increase in FC 20,000
Decrease in income 20,000
Current C. Margin = (400 speakers x $ 100) = 40,000
Proposed C. Margin = (500 x $ 80) 40,000
Decrease in CM -
Increase in FC 20,000
Decrease in income 20,000
 1 Km = Rs 5
Rent Production
1 10,000 5 50,000 1 50,000 10,000
2 12,000 5 60,000 2 50,000 25,000
3 6,000 5 30,000 3 50,000 15,000
- 4 50,000 30,000
- 5 50,000 100,000

LR
1 1,200 500
2 1,500 500
3 1,800 500
4 900 500
5 2,000 500
Rate
5.00
2.00
3.33
1.67
0.50

0321-9222512
 Break even Analysis:
### Computation of Break even analysis by Equation method:
Break even point (in amount)

Sale = Variable cost + Fixed Cost + Desired Profit

### Computation of Break even analysis by Formula:

Break even point (in amount) = Fixed Cost
C.M. Ratio

Break even point (in units) = Fixed Cost

C.M. per unit

Target Profit Analysis:

It is done by break even analysis (equation method)
 Margin of Safety:
Margin of safety is the excess of budgeted (or actual) sales over the break even sales.
BEP provided the line below which company suffered loss. Higher the margin of safety, the
lower the risk of not breaking even.

a) Margin of Safety = Total Sales (actual) - Break even sales

b) Margin of Safety (in Percentage) = Margin of Safety (in amount)

Total budeted (or actual) sales

c) In a single product firm, the margin of safety can also be expressed in terms of
number of units.
Margin of Safety (in units) = Margin of Safety (in amount)
Sales price per unit
Or
Margin of Safety (in units) = Actual units sold - BEP (in units)
 Example:
### MOS = $100,000 - $87,500 $ 12,500

### MOS (%) = $ 12,500 12.5%

$100,000

### MOS (in units) = $ 12,500 50 units

$250

MOS (in units) = 400 speakers - 350 speakers

MOS (in units) = 50 units

Operating Leverage:
It is a measure of how sensitive net operating income is to percentage changes in sales.
It means that if operating leverage is high then the small percentage change can produce
large increasein net income and vice versa.

Example: Farm A Farm B

Sales 100,000 100,000 Sales 100,000
Less: Variable cost (60,000) (30,000) Total cost 90,000
 Contribution Margin 40,000 70,000 Profit 10,000
Less: Fixed Cost (30,000) (60,000)
Net Operating Income 10,000 10,000

Degree of operating leverage = Contribution Margin

Net operating Income

DOL (A)= 40,000 4 times

10,000

DOL (B)= 70,000 7 times

10,000

Consider the impact of change of 10% increase in sales of two companies

Farm A Farm B
Sales 100,000 92,000 100,000 92,000
Less: Variable cost (60,000) (55,200) (30,000) (27,600)
Contribution Margin 40,000 36,800 70,000 64,400
Less: Fixed Cost (30,000) (30,000) (60,000) (60,000)
Net Operating Income 10,000 6,800 10,000 4,400
 Change in Net Operating Income (in amount) (3,200) (5,600)

Change in Net Operating Income (in times) (3,200) (5,600)

10,000 10,000

Changes in Percentage (32) (56)

Consider the impact of change of 12% decrease in sales of two companies

Farm A Farm B
12% 12%
Sales 100,000 88,000 100,000 88,000
Less: Variable cost (60,000) (52,800) (30,000) (26,400)

Contribution Margin 40,000 35,200 70,000 61,600

Less: Fixed Cost (30,000) (30,000) (60,000) (60,000)
Net Operating Income 10,000 5,200 10,000 1,600
Change in Net Operating Income (in amount) (4,800) (8,400)

Change in Net Operating Income (in times) (4,800) (8,400)

10,000 10,000

Changes in Percentage (48) (84)

Review Problem
Total Per unit
Sales (20,000 units) 1,200,000 60
Less: Variable cost (900,000) (45)
Contribution Margin 300,000 15
Less: Fixed Cost (240,000)
Net Operating Income 60,000

Required:
1 Compute Company's C. M ratio and Variable expense ratio.

2 Compute the company's break even point (in units) and (in dollars), by equation method.

4 Refer to the original data. Assume that next year management wants the company
earn a min. profit of $ 90,000. How much units will have to be sold to meet
this target profit figure?
5 Refer, to the original data, Compute the company's margin of safety (in dollar)
and (in percentage)

6
a Compute the company degree of operating leverage at the present level of sale

b Assume that through a more intense effort by the sales staff the company sale increase
by 8% next year. By what percentage would you expect net operating income increases?
Use the operating leverage concept.

c Verify your answer through Income Statement.

7 In an effort to increase the sales and profit, management is considering the use of
a higher quality speaker. The higher quality speaker would increase the variable cost
by $3 per unit, but management could eliminate one quality inspector who is paid a
salary of #30,000 per year. The sales manager estimate that the higher quality speaker
would increase annual sales by atleast 20%.

a) Assuming that chanes are made as described above, prepare projected

income statement for next year. Show a data on a total, per unit and percentage basis.

b) Compute the company's new breakeven point in both units and dollar of sales.
Use C.M method.

c) Would you recommend that the change be made?

 Product A Percentage Product B Percentage Total Amount Percentage
Sales 20,000 1 80,000 1 100,000 1
Less: Variable cost (15,000) 1 (40,000) 1 (55,000) 1
CM 5,000 0 40,000 1 45,000 0
Fixed Cost (27,000)
Net Income 18,000

Multiple BEP (in amount) = Fixed Cost 27,000 60,000

Overall CM% 0

Total Product A Product B

Sales (Multiple product BEP) 60,000 12,000 48,000
Less: Variable cost (33,000) (9,000) (24,000)
CM 27,000 3,000 24,000
Fixed Cost (27,000)

Product A Percentage Product B Percentage Total Amount Percentage

Sales 80,000 1 20,000 1 100,000 1
Less: Variable cost (60,000) 1 (10,000) 1 (70,000) 1
CM 20,000 0 10,000 1 30,000 0
Fixed Cost (27,000)
Net Income 3,000
Multiple BEP (in amount) = Fixed Cost 27,000 90,000
Overall CM 0

Total Product A Product B

Sales (Multiple product BEP) 90,000 72,000 18,000
Less: Variable cost (63,000) (54,000) (9,000)
CM 27,000 18,000 9,000
Fixed Cost (27,000)