Session 3, Lecture 4

Cost Volume Profit Analysis

 Cost behaviour – recap
 CVP analysis
 Break-even charts and calculations
 Contribution
 Other measures
 Using of break-even analysis
 Relevant ranges of output

 Reading: Management and cost accounting

chapter 8
 The way costs change with the level of
activity

 Variable costs
 Fixed costs
 Stepped fixed costs
 Semi-variable costs
◦ Can be split into fixed and variable
elements
 Based on short-term relationship
between costs, volume and sales revenue
 Provides information for decision making
 Useful for short-term decisions

 Key example – break-even analysis

 Identify level of output at which business
will ‘break-even’
Revenue / Sales revenue
Break-even point
costs (£)

PROFIT
Total costs

Variable costs

LOSS
Fixed costs

Volume of activity (units of output)

 Profit = sales revenue – total cost
 Profit = sales revenue – (fixed + variable costs)
 Profit = quantity×price
– fixed costs – (quantity×variable cost per
unit)
 Profit = quantity×(price –variable cost per unit)
– fixed costs
 At break even point, profit = 0
 Then quantity×(price –variable cost per unit)
= fixed costs
 or quantity = fixed costs
price – variable cost per unit
 Sales price – variable cost per unit is
contribution
 Contribution is the surplus remaining after
deducting variable costs from the sales price
 Which is the amount left to put towards paying
for fixed costs and to provide for profit

 So break-even quantity is given by:

 Number of units = fixed costs
contribution per unit
 Margin of safety
 Difference between planned output and break-even
quantity
 May be expressed as a percentage

 Contribution / sales ratio

 Proportion of each £1 sale available to cover fixed
costs and provide profit
 C/S ratio = contribution per unit / sales price

 To make target profit:

 Number of units = fixed costs + target profit
contribution per unit
 All other variables remain constant
 Single product or constant sales mix
 Linear relationship between volume, cost
and revenue
 Costs can be accurately divided into fixed
and variable elements
 Applies to short-term horizon
 Applies to relevant range
 Break-even points Sales revenue
Revenue /
costs (£)

Total costs

Fixed costs

Relevant ranges
As far as next
step change

Volume of activity (units of output)

 Real situation in most businesses
 Single product analysis does not work
 One solution: consider standard batch of
products based on expected sales mix
 Calculate break even point for batches
◦ Use weighted average C/S ratio to calculate break-
even point for standard mix
◦ C/S ratio = total expected contribution/expected
sales rev
 Use profit-volume chart
◦ Individual products in order of profitability based on
C/S ratio
Operating Most profitable
profit ($) product first

Sales in
constant mix

Sales
revenue
Expected sales ($)
revenue ($)
 Why do businesses such as airlines pay
attention to the break-even point?
 CIMA 2009 survey of companies
worldwide:
◦ Around 40% of all companies use
break-even analysis
◦ 50% of very large companies use it
 Break-even points and load factors for Ryanair
100%

80 82 83 83
82 81 82
79
73 72
67 70 70
60

40

20

0 2011
2008 2009 2010 2012 2013

Break-even Load factor

Figure 3.7 Break-even and load factors at Ryanair