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Attribution Non-Commercial (BY-NC)

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Cost-Volume-Profit Analysis

Cost-Volume-Profit

Analysis

CVP analysis is a technique for studying the relationship between

cost, volume and profits. Examines the behavior of total

revenues, total costs, and operating income as changes occur in

the output level, selling price, variable costs or fixed cost

It can be used to answer the questions like:

a. How much sales should be made to avoid the losses?

b. How much should be the sales to earn a desired profit?

c. What will be the effect of change in prices, costs and volume on

profits

d. Which product or product mix is most profitable?

e. Should we manufacture or buy some product or component?

Page 67

Assumptions of CVP

Analysis

Expenses can be classified as either variable or fixed.

CVP relationships are linear over a wide range of production and

sales.

Sales prices, unit variable cost, and total fixed expenses will not vary

within the relevant range.

Volume is the only cost driver.

The relevant range of volume is specified.

Inventory levels will be unchanged.

The sales mix remains unchanged during the period.

revenues change in relation to production and sales

costs and prices are known

if more than one product exists, the sales mix is constant

we can ignore the time value of money

Objectives

Identify how changes in volume affect costs.

Use CVP analysis to compute breakeven point.

Use CVP analysis for profit planning and graph the

cost-volume-profit relations

Use CVP method to perform sensitivity analysis.

Contribution Margin

Contribution margin is equal to the difference between total revenue and total

variable costs

Contribution margin per unit

= Selling price - Variable cost per unit

Contribution margin percentage

= Contribution margin per unit / selling price per unit

Total for

Per Unit 2 units %

Variable costs 120240 60%

Contribution margin 80160 40%

Pages 68 - 69

Contribution Margin

Income Statement

Sales

- Variable Costs

Contribution Margin

- Fixed Costs

Operating Income

Variable costs

(20,000 x 70) (1,400,000)

Contribution margin 300,000

Contribution Margin

Income Statement

Income statement that groups line items by cost behavior to highlight the contribution margin

Packages Sold

0 12 2540

Revenue 0200 4005,0008,000

Variable costs 0120 2403,0004,800

Contribution margin 080 1602,0003,200

Fixed costs 2,0002,0002,000 2,0002,000

Operating income (2,000)(1,920)(1,840) 01,200

Page 69

Computing Break-Even

Point

company earns neither a profit nor

incurs a loss.

Breakeven Point

Quantity of output where total revenues equal total costs

Point where operating income equals zero

= Fixed costs / Contribution margin per unit

= 2,000 / 80

= 25 units

= Fixed costs / contribution margin %

= 2,000 / 40%

= 5,000 RS.

Page 71

Margin Of Safety

Excess of actual or budgeted sales over

the break – even sales is known as MOS

It can be improved by taking the following

steps:

1. By increasing the level of production or

selling price

2. By reducing fixed or variable cost.

Angle of Incidence

Is the angle between the sales line and the

total cost line formed at the break even point

where the sales line and the total cost line

intersects each other. It indicates the profit

earning capacity of a business.

A Large angle of incidence indicate a high

rate of profit and a small angle of incidence

indicates a low rate of profit

Types of

Costs

Variable

Fixed

Mixed

Total Variable Cost

Total variable costs change

when activity changes.

Total Long Distance

Telephone Bill

on how many minutes

you talk.

Minutes Talked

Variable Cost Per Unit

Variable costs per unit do not change

as activity increases.

The cost per long

Telephone Charge

distance

Per Minute

minute talked is

constant.

For example, 2 Rs. per

minute.

Minutes Talked

Total Fixed Cost

Total fixed costs remain unchanged

when activity changes.

Telephone Bill

Monthly Basic

Variable Costs

Example

24 –

18 –

12 –

6 –

) s dnas uo ht(

ai r a Vl at o T

–

–

0 1 2 3 4 5

Volume

(Thousands of passengers)

Mixed Costs

Contain fixed portion that is incurred

even when facility is unused & variable

portion that increases with usage.

Example: monthly electric utility

charge

Fixed service fee

Variable charge per kilowatt hour used

Mixed Costs

Total Utility Cost

ost

d c Variable

i xe

l m Utility Charge

o ta

T

Fixed Monthly

Utility Charge

Activity (Kilowatt Hours)

Preparing a CVP Chart

➊ Plot total fixed costs on the vertical axis.

Costs and Revenue

in Dollars

Total costs

equal to the unit variable cost.

Volume in Units

Preparing a CVP Chart

Starting at the origin, draw the sales line Sales

with a slope equal to the unit sales price.

Costs and Revenue

in Dollars

Total costs

Break-even

Point

Volume in Units

Various Sales Levels

Example

What operating income is expected when

sales are 80,000 units?

Less: Variable exp (10/unit) 8,00,000

Contribution 8,00,000

Less: Fixed cost 4,00,000

Operating profit 4,00,000

Computing Multiproduct

Break-Even Point

Unit contribution margin is replaced

with contribution margin for a

composite unit.

A composite unit is composed of

specific numbers of each product in

proportion to the product sales mix.

Sales mix is the ratio of the volumes

of the various products.

Computing Multiproduct

Break-Even Point

The resulting break-even formula

for composite unit sales is:

= Contribution margin

in composite units

per composite unit

Computing Multiproduct

Break-Even Point

Step 2: Compute break-even point in

composite units.

Break-even point Fixed costs

= Contribution margin

in composite units

per composite unit

900,000

Break-even point =

in composite units 450 per composite

unit

Break-even point = 2,000 composite units

in composite units

Computing Multiproduct

Break-Even Point

A company sells windows and doors.

They sell 4 windows for every door.

Windows Doors

Selling Price $200 $500

Variable Cost 125 350

Unit Contribution $ 75 $ 150

Sales Mix Ratio 4 1

Computing Multiproduct

Break-Even Point

Step 1: Compute contribution margin per

composite unit.

Windows Doors

Selling Price $200 $500

Variable Cost 125 350

Unit Contribution $ 75 $ 150

Sales Mix Ratio

Composite C/M

Computing Multiproduct

Break-Even Point

doors that must be sold to break even.

Sales Composite

Product Mix Units Units

Window 4 × 2,000 = 8,000

Door 1 × 2,000 = 2,000

Multiproduct Break-Even

Income Statement

Step 4: Verify the results.

Se lling Price $200 $500

Va ria ble Cost 125.00 350.00

Unit Contribution $ 75.00 $ 150.00

Sa le s Volum e × 8,000 × 2,000

Tota l Contribution $ 600,000 $ 300,000 $ 900,000

Fix e d Costs 900,000

Incom e $ 0

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