Cost Volume Profit Analysis (CVP)

Cost Volume Profit analysis can be used to determine the effects of changes in an organisation’s
sales volume on its costs, its revenue and its profit. CVP utilizes variable costing information (as
opposed to absorption costing information).

Contribution Margin is the amount generated by sales after all variable costs have been deducted,
as follows:

Revenue per unit – Variable costs per unit = Contribution per unit

This is called the contribution margin and can be expressed as

 Rands per unit, or as

 a % of Revenue per unit

Variable costs are those that vary with the quantity of items manufactured and sold e.g. raw materials,
temporary wages, electricity and water.

Example:

Rands per unit % of Revenue per unit

Expected revenue 250
Less: Variable costs 150 60%
Contribution Margin 100 40%

Note that the above calculations are all “per unit”. Once the number of units is determined, the total
contribution can be calculated. The total contribution is then the amount that is available to contribute
towards paying the fixed costs.

Fixed costs are those that remain the same regardless of how many items are produced e.g. rent,
depreciation and salaries.

Units Rand (total) Rand per unit

Expected revenue 100 250 000 250
Less: Variable costs (150 000) 150
Contribution margin 100 000 100
Less: Fixed costs (80 000)
Expected profit 20 000
Break even analysis:

Break-even is the point at which the business covers their total costs exactly with the revenue that is
generated i.e. profit will equal R0. We can calculate break-even in units and in Rands.

Break-even in units: There are 2 methods to approach this…

Example: If selling price per unit is R200, variable costs per unit is R95 and fixed costs are R24 990,
how many units must be sold in order to break even?

1. Method 1: Equation Method

Units Rand (total) Rand per unit

Expected revenue ? = 200 x ? 200
Less: Variable costs = 95 x ? 95
Less: Fixed costs (24 990)
Expected profit 0

Now, Solve for x:

Expected Revenue – Variable costs – Fixed costs = expected profit

Selling price/unit x units – variable costs/unit x units – 24 990 = R0
200(x) – 95(x) – R24 990 = R0
105(x) = 24 990
x = 24 990/105
x = 238 units

2. Method 2: Units Contribution Method

Break-even point = (Fixed costs + Profit) / Contribution margin

= (24 990 + 0) / (200 – 95)
= 24 990/105
= 238 units

Break-even in Rands: Sometimes management wants to express the break-even point in Rands,
rather than in units. There are 2 methods to calculate this:

1. Method 1: Multiply the break-even units (calculated above) by the sales price per unit.
238 units x R200 = R47 600

2. Method 2: Break even Rands formula:

Break–even Rands = Fixed costs / (unit contribution margin/unit sale price)
= 24 990/(105/200)
= R47 600
Required sales to achieve Targeted net profit:

To calculate break-even above, we set expected profit at R0. This analysis is similar to break-even
analysis except that our expected profit is no longer equal to R0, there is a targeted profit that must
be reached that is higher than R0 and we need to calculate how many items (or what Rand value) must
be sold to achieve the targeted profit.

Both methods used for break-even analysis can thus be used to calculate targeted net profit. The only
difference is that profit will equal the “targeted profit” given in the question, instead of R0.

Margin of Safety:

This refers to the surplus amount of sales that were made when compared to the break-even sales
amount. This can be expressed in Rands or in units.

Margin of safety = Actual sales quantity – Expected sales for break-even

In our example above the break-even quantity was 238 units.

In Rands, this amounts to expected sales of R200 x 238 units = R47 600.
At the end of the year, it was calculated that the actual sales revenue was R51 400 (i.e. 257 units).
The margin of safety was thus R51 400 – R47 600 = R3 800.
This can also be expressed in units: 257 units – 238 units = 19 units.

Break-even analysis with Multiple products:

When an entity has several products the sales mix is used to conduct the break-even analysis, as
follows:

Product A Product B Product C Total

Selling price per unit R2 000 R2 500 R250
Variable costs per unit R850 R1 000 R100
Contribution per unit R1 150 R1 500 R150
Directly attributable fixed costs per annum - - R15 000
Common fixed costs per annum R810 000
Expected sales mix 3 2 1

Step 1: Calculate the weighted average contribution margin across all the products:
= (R1 150+R1 500+R150) / (3+2+1)
= R1 100

Step 2: Use the above break-even formula replacing the contribution margin with the weighted
average contribution margin. This will arrive at the total number of break-even units:
= Total fixed costs / weighted average contribution margin
= (R15 000 + R810 000)/R1 100
= 750 units

Step 3: Split the total number of break-even units according to the sales mix weighting:
Product A = 750 x3/6 = 375 units
Product B = 750 x 2/6 = 250 units
Product C = 750 x 1/6 = 125 units