The Institute of Chartered Accountants of Bangladesh (ICAB)

BUSINESS AND FINANCE

(CA Professional Stage Certificate Level)

Chapter-07
The Business’s Finance Function
(Part-02)

Abdul Hamid, FCA

Email: ahamid1014@gmail.com
Cell: 01755599931
 Cost-Volume-Profit Analysis
The managers of profit-seeking organizations usually study the effects of output volume on
revenue (sales), expenses (costs), and net income (net profit). This study is commonly called
cost-volume-profit (CVP) analysis. The managers of nonprofit organizations also benefit from
the study of CVP relationships. Why? No organization has unlimited resources, and knowledge
of how costs fluctuate as volume changes helps managers to understand how to control costs. For
example, administrators of nonprofit hospitals are constantly concerned about the behavior of
costs as the volume of patients fluctuates.
Hence, cost-volume-profit (CVP) analysis is a study of the effects of output volume on revenue
(sales), expenses (costs), and net income (net profit).
Mrs. X predicts the following revenue and expense relationships.

PER UNIT PERCENTAGE OF SALES

Selling price Tk. 500 100%
Variable cost of each item Tk. 400 80%
Selling price less variable cost/Contribution per unit Tk. 100 20%
Rent Tk. 10,000
Wages tor replenishing and servicing Tk. 45,000
Other fixed expenses Tk. 5,000
Total fixed expenses per month Tk. 60,000

 Break-Even Point-Contribution Margin and Equation Techniques

The most basic CVP analysis computes the monthly break-even point in number of units and in
Taka sales. The break-even point is the level of sales at which revenue equals expenses, and net
income is zero. The business press frequently refers to break-even points. Hence, break-even
point, the level of sales at which revenue equals expenses, and net income is zero.
Total Sales = All types of Variable Cost (For Sales Units) + Total Fixed Cost for a particular
period + Profit/ (Loss).
(Unit Sale X Selling price per unit) =(Unit sales X Variable Cost per unit) + Total Fixed Cost
+Profit/ (Loss).
Sales–All Variable Cost (For Sales Units)
=Contribution = Total Fixed Cost + Profit / (Loss)
Break Even Sales (in Unit) =All variable Cost + Total Fixed Cost +Zero Profit/ (loss)
Break Even Sales (in Unit)= Total Sales – All Variables Cost (For Sales Units)
= Contribution= Total Fixed Cost

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 Total Fixed Cost
∴
ContributionPer Unit
Fixed Cost
BEP (Unit) =
Contribution per Unit

60,000
= = 600
100
BEP (in Tk) = 600 ⨉ 500 = Tk. 3,00,000

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4
The study of cost-volume-profit relationships is often called break-even analysis. This term is
misleading, because finding the break-even point is often just the first step in a planning
decision. Managers usually concentrate on how the decision will affect sales, costs, and net
income.

 Contribution-Margin Technique
Every unit sold generates a contribution margin or marginal income, which is the sales price
minus all the variable expenses per unit. The contribution margin per unit is:

Unit sales price Tk. 500

Unit variable cost 400
Unit contribution margin to fixed costs and net income Tk. 100

Method of calculating Break Even Point:

Fixed Cost
1. BEP (Unit) = Contribution per Unit

Break even point in sales value

2. BEP (Unit) = Selling price per unit

Fixed Cost
3. BEP (in Taka) = Contribution per Unit ⨉ Sellingprice per unit

Fixed Cost
4. BEP (in Taka) = Contribution ⨉ Sales

Fixed Cost
5. BEP (in Taka) = PV Ratio / CM Ratio

Fixed Cost
6. BEP (in Taka) = Variable Cost
1−
Sale

7. BEP (in Taka) = Variable Cost up to BEP + Fixed Cost

8. BEP (in Taka) = Sales − Margin of Safety

 Profit Volume (PV) Ratio or Contribution Margin (CM) Ratio

The PV Ratio or, CM Ratio excesses the relation of contribution to sales. It shows what percent
of each Taka sells is available for covering of fixed cost and the making of a net income.
Contribution
1. PV Ratio = Sales

Sales−Variable Cost
2. PV Ratio = Sales

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 Fixed Cost+Profit
3. PV Ratio = Sales

4. PV Ratio = 1 − Variable cost ratio

Variable Cost
=1−
Sales
Fixed Cost
5. PV Ratio = Break Even Sales

Change in Contribution
6. PV Ratio = Change in Sales

Change in Profit
7. PV Ratio = Change in Sales

Contribution per unit

8. PV Ratio = Selling price per unit

The condensed income statement at the break-even point could be presented as follows:

Per Unit Percentage

Unit 600
Sales Tk. 3,00,000 Tk. 500 100%
Variable Costs Tk. 2,40,000 Tk. 400 80%
Sales less variable costs Tk. 60,000 Tk. 100 20%
Fixed costs Tk. 60,000
Net income Tk. 0

Sometimes the unit price and unit variable costs are not known. This situation is common at
companies that sell more than one product because no single price or variable cost applies to all
products. For example, a grocery store sells hundreds of products at many different prices. A
break-even point in units would not be meaningful. In such cases, we can use total sales and total
variable costs to calculate variable costs as a percentage of each sales taka.

Consider our Previous example:

Sales price 100%

Variable expenses as a percentage of dollar sales 80%
Contribution-margin percentage 20%

Therefore, 20% of each sales taka is available for the recovery of fixed expenses and the making
of net income: Tk. 60,000÷0.2 = Tk. 3,00,000 sales needed to break even. The contribution
margin percentage is based on taka sales and is often expressed as a ratio (.20 instead of 20%).
Using the contribution-margin percentage, we can compute the break-even volume in taka sales
without determining the break-even point in units.

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 Margin of Safety
Sales beyond the Break Even Sales is called the Margin of safety. In other words, the excess of
total sales over Break Even sales is called Margin of safety. A high margin of safety is a strong
position whereas a small margin of safety is a difficult position.

Methods of calculating Margin of Safety

1. MS = Total Sales (actual or budgeted) − Break even sales

Fixed Costs
2. MS = Sales − PV Ratio

MS
3. MS Ratio = Sales X 100

Sales−Break even sales

4. MS Ratio = Sales

Profit %
5. MS Ratio = PV Ratio
Variable Cost
1. Variable Cost = Sales – Contribution
2. Variable Cost = Sales – (Fixed cost + Profit)
3. Variable Cost = Sales – (Sales ⨉ PV Ratio)

Contribution
1. Contribution = Sales – Variable Cost
2. Contribution = Sales ⨉ PV Ratio
3. Contribution = Fixed Cost + Profit

Fixed Cost
1. Fixed Cost = Contribution − Profit
2. Fixed Cost = Sales − Variable Cost − Profit
3. Fixed Cost = Sales ⨉ PV Ratio − Profit
4. Fixed Cost = Break Even Sales ⨉ PV Ratio

Profit
1. Profit = Sale − Variable Cost − Fixed Cost
2. Profit = Contribution – Fixed Cost
3. Profit = Sales ⨉ PV Ratio − Fixed Cost
4. Profit = MS ⨉ PV Ratio
5. Profit % = CM Ratio ⨉ MS Ratio

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 Equation Technique
The equation technique is the most general form of analysis, the mathematical model, as follows:

Sales - Variable Expenses - Fixed Expenses = Net Income

That is,

(𝐮𝐧𝐢𝐭𝐬𝐚𝐥𝐞𝐬𝐩𝐫𝐢𝐜𝐞𝐗𝐧𝐮𝐦𝐛𝐞𝐫𝐨𝐟𝐮𝐧𝐢𝐭𝐬) − (𝐮𝐧𝐢𝐭𝐯𝐚𝐫𝐢𝐚𝐛𝐥𝐞𝐜𝐨𝐬𝐭𝐗𝐧𝐮𝐦𝐛𝐞𝐫𝐨𝐟𝐮𝐧𝐢𝐭𝐬) − 𝐟𝐢𝐱𝐞𝐝𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬 = 𝐧𝐞𝐭𝐢𝐧𝐜𝐨𝐦𝐞

At the break-even point net income is zero.

Sales - Variable Expenses - Fixed Expenses = 0

Let N = number of units to be sold to break even

(N ⨉ 500) – (N ⨉ 400) – 60,000 = 0

=>500N –400N – 60,000 = 0
=>100 N= 60,000
=>N= 600 units

 Changes in Fixed Expenses

The fixed expenses would increase from Tk.60,000 to Tk.70,000, so

fixed expenses 70,000

break even volume in units = = = 700 units
Contribution margine per unit 100

fixed expenses 70,000

break even volume in Tk = = = Tk. 3,50,000
Contribution margine ratio 0.20

Note that a one-sixth increase in fixed expenses altered the break-even point by one-sixth: from
600 to 700 units and from Tk. 3,00,000 to Tk. 3,50,000. This type of relationship always exists,
if everything else remains constant.

Companies frequently lower their break-even points by reducing their total fixed costs. For
example, closing or selling factories decreases property taxes, insurance, depreciation, and
managers' salaries.

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 Target Net Profit and an Incremental Approach
Managers can also use CVP analysis to determine the total sales, in units and taka, needed to
reach a target profit. For example, Tk. 4800 per month the minimum acceptable net income.
How many units will have to be sold to justify the adoption of the example? How does this figure
"translate" into taka sales?

Now the targets, however, are expressed in the equations:

target sales − variable expenses − fixed expenses = target net income

fixed expenses + target net income

target sales volume in units =
Contribution margine per unit
60,000 + 4,800
= = 648 units
100

 Required sales for a target or desired net income before tax

Fixed Costs +Desired profit
1. Required sales (in units) = Contribution per unit

Fixed cost + Desired Profit

2. Required sales (in Taka) = X Selling price per unit
Contribution per unit

Fixed cost + Desired Profit

3. Required sales (in Taka) = PV Ratio/ CM Ratio

Desired Contribution
4. Required sales (in Taka) = PV Ratio

Fixed cost + Desired Profit

5. Required sales (in Taka) = Variable Cost
1−
Sales

6. Required sales (in Taka) = Variable Cost + Fixed Cost + Target net income

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 Impact of Income Taxes
Our CVP analysis, we discussed the sales necessary to achieve a target income before income
taxes of Tk. 4,800. If an income tax were levied at 40%, the new result would be

Income before income tax Tk. 4,800

Income tax Tk. 1,920
Net income Tk. 2,880

Note that

net income = income before income taxes − 0.40 (income before income taxes)
net income = 0.60 (income before income taxes)
Net income
income before income taxes =
0.60
or
target after tax net income
Target Income before Income taxes =
1 − tax rate
Tk. 2,880 Tk. 2,880
Target Income before Income taxes = = = Tk. 4,800
1 − 0.40 0.60

Suppose the target net income after taxes was Tk. 2,880. The only change in the general equation
approach would be on the right-hand side of the following equation:

target after tax net income

Target Seles − Variable expenses − fixed expenses =
1 − tax rate

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 Required sales for a target or desired net income after tax
Desired profit
Fixed cost+
1. Required Sales (in units) = 1−Tax ratio
Contribution per unit

Desired profit
Fixed cost+
2. Required Sales (in Taka) = 1−Tax ratio
PV ratio
Desired profit
Fixed cost+
3. Required Sales (in Taka) = 1−Tax ratio
Variable cost
1−
Sales

Desired profit
Fixed cost+
4. Required Sales (in Taka) = 1−Tax ratio
⨉ Selling price
Contribution per unit
 Sales-Mix Analysis
To emphasize fundamental ideas, the cost-volume-profit analysis in this chapter has focused on a
single product. Nearly all companies, however, sell more than one product. Sales mix is defined
as the relative proportions or combinations of quantities of products that comprise total sales. If
the pro- portions of the mix change, the cost-volume-profit relationships also change.

Suppose Ramos Company has two products, wallets (W) and key cases (K). The income budget
follows:
WALLETS KEY CASES
TOTAL
(W) (K)
Sales in units 3,00,000 75,000 375,000
Sales @ Tk.8 and Tk.5 Tk.24,00,000 Tk.3,75,000 Tk.27,75,000
Variable expenses @ Tk.7 and Tk.3 21,00,000 2,25,000 23,25,000
Contribution margins @ Tk.1 and
Tk. 3,00,000 Tk.1,50,000 Tk. 4,50,000
Tk.2
Fixed expenses 1,80,000
Net income Tk. 2,70,000

For simplicity, the typical answer assumes a constant mix of 4 units of W for every unit of K.
Therefore, let K = number of units of product K to break even, and 4K = number of units of
product W to break even:

Sales − Variable Expenses − Fixed Expenses = Zero Income/(Loss)

Tk. 8(4K) + Tk. 5(K) − Tk. 7(4K) − Tk. 3(K) − Tk. 180,000 = 0

Tk. 32K + Tk. 5K − Tk. 28K − Tk. 3K − Tk. 180,000 = 0

Tk. 6K = Tk. 180,000

K = 30,000
4K = 120,000 = W

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The break even point is 30, OOOK + 120, OOOW = 150,000 units.
This is the only break-even point for a sales mix of four wallets for every key case. Clearly,
however, there are other break-even points for other sales mixes. For instance, suppose only key
cases were sold, fixed expenses being unchanged:

fixed expenses
break even point =
Contribution margin per unit

Tk. 180,000
=
Tk. 2

= 90,000 key cases

If only wallets were sold:

Tk. 180,000
break even point =
Tk. 1

= 180,000 wallets

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