Cost-

Volume-
Profit
Analysis
B E AT R I C E L E U S T E A N
More than 50% of the companies use
one form or another of the CVP analysis
Cost-volume-profit analysis (CVP) examines how total revenues, total costs and operating profit
evolve as changes occur in production level', in sales price, in unit variable cost and/or in fixed costs of
a product.

CVP analysis guides planning at the management’s level.

The questions CVP analysis
answers
Q1
How will total costs and total
revenues be affected if we
change the level of production,
if we sell for 1,000 units more?
What happens if?
Q2 Q3
How will the level of How will costs, sales prices and
production be influenced production levels evolve if we
if we increase or reduce expand into foreign markets?
the selling price?
What happens if? What happens if?
 FUNDAMENTAL ASSUMPTIONS AND TERMINOLOGY OF
COST-VOLUM-PROFIT ANALYSIS
1. Revenue and cost changes occur only due to changes in the number of units of goods (or services) produced
and sold - The number of product units is the only determinant of revenue and the sole determinant of costs. In
the same way that a cost determinant is a factor influencing costs, a revenue determinant is a variable, such as
volume, that influences revenue.
2. Total costs may be broken down into a fixed component, which does not vary once volume of production, and a
component that varies in relation to production volume. In a similar way, fixed costs include both direct fixed costs of a
product, as well as indirect fixed costs.
3. When plotted, the evolution of total revenue and total costs is linear (i.e. can be illustrated by a straight line) in
relation to the volume of production within a relevant interval (and a relevant time period).
4. The selling price, unit variable cost and fixed costs are known and constant (within the limits of a relevant interval
and period).
5. The analysis refers either to a single product or assumes (when more products are produced and produced) that the
proportion of the different products in total will remain constant as the total number of units produced changes.
6. All income and costs can be summarized and compared without taking into account the value of money over time.
Net Profit = Operating Profit - Profit Tax
Net profit is equal to operating profit, plus non-operating income (such as interest income),
minus expenses outside the operating activity (such as interest expenses), minus corporation
tax. To simplify, in this chapter we will assume that revenues and expenses unrelated to the
operating activity are null and core.

Operating(operational) profit= Total operating income – (Cost of

goods sold + operating expenses (excluding corporation tax))
MECHANISM OF COST-VOLUM-
PROFIT ANALYSIS
Example: A company plans to market a set of computer applications, during a two-day computer
sales exhibition to be held in Chicago. It can purchase these sets of computer applications from a
specialized wholesaler at the unit price of $120, with the possibility to refund all unpaid sets against
full refund of their purchase price. The Do-All Software set will be sold at the unit price of $200. The
company has already paid $2,000 to Computer Conventions to rent the stand for two days. There are
supposed to be no other costs. What profit will the company make from selling different amounts of
Do-All Software soft-ware sets?
The only values that change when selling different amounts of computer application sets are total revenues
and total variable costs. The difference between total revenues and total variable costs is called marginal
contribution. Marginal contribution shows why operating profit changes as change number of units
produced.
 No. of soft-ware sold (units/programmes sold)

  0 1 5 25 40

Revenues, calculated for 0 200 1000 5000 8000

200$/unit

Variable costs, calculated 0 120 600 3000 4800

for 120$/unit

Marginal contribution 0 80 400 2000 3200

calculated for 80
$/unit

Fixed costs $ 2000 2000 2000 2000 2000

Operational Profit $ -2000 -1920 -1600 0 1200

Remember!!
Complementary indicator of marginal percentage contribution (CM%) is the variable percentage cost (CV%). In other words, CM%+CV
%=1.

SP= Selling Price

UVC= Unit Variable Cost

UMC= Unit Marginal Contribution = SP-UVC

MPC% = Marginal Percentage Contribution (UMC/SP)

FC= Fixed Costs

Q=Quantity of manufactured (produced) sold units

OP=Operational Profit

TOP=Targeted Operational Profit

TNP = Targeted Net Profit

Break-even
point
analysis
T H AT Q U A N T I T Y O F S A L E S
F O R W H I C H T H E T O TA L
R E V E N U E E Q U A L S T H E T O TA L
COSTS.
Equation method

UVCx
SPxQ - - FC = OP
Q
Marginal
contribution
method
(SPxQ)-(UVCxQ)-FC=OP
Break-even point Fixed costs
(SPxQ)-(UVCxQ)=OP+FC expressed in number =
of units
Unit marginal contribution
(SP-UVC)xQ= FC+OP
UMCxQ=FC + OP Break-even point 2.000$
expressed in number = = 25 units
Q = (FC+OP)/UMC of units
80$/unit

Quantity for break-even point is

found if OP=0.
Graphical
method
The Right to total costs. The total
cost line represents the sum of
fixed costs and variable costs.
The right to total income. A suitable
starting point is the appropriate zero
revenue for 0 units sold.

The break-even point is the amount

of units sold for which right total
costs and total revenue line intersect.
USE OF COST-VOLUME-PROFIT ANALYSIS
IN THE DECISION-MAKING PROCESS

The decision to advertise

The decision to reduce the selling price

 40 units sold no 44 units sold with Diferences
publicity publicity
Marginal $3200 $3520 $320
contribution($80x40;
$80x44)
Fixed Costs 2000 2500 500
Operational Profit $1200 $1020 $-180
Marginal contribution in case of price reduction to $175:

(175$-115S) per unit x 50 units 3000$

Marginal contribution in case of price maintenance at $200:

($200-$120) per unit x 40 units 3.200$

Change of marginal contribution due to a price diminishing -200$
SENSITIVITY AND INCERTITUDE
ANALYSIS
Assessing the sensitivity of operating profit in relation to various
possible situations allows managers to better understand what
might possibly happen before making any expense.

When they are not known with certainty, the component

values of the CVP model must be estimated. These estimates
require reasoning and may differ between managers in terms
of estimating the unit variable cost (UVC), for example.
Accountants perform sensitivity analyses to determine whether
these different estimates of UVC significantly influence the
results of the CVP analysis.
Fixed costs Unit variable costs $0 $1200 $1600 $2000
$2000 $100 4000 6400 7200 8000
120 5000 8000 9000 10000
150 8000 12800 14400 16000
2400 100 4800 7200 8000 8800
120 6000 9000 10000 11000
150 9600 14400 16000 17600
2800 100 5600 8000 8800 9600
120 7000 10000 11000 12000
150 11200 16000 17600 19200
PLANIFICATION OF COSTS AND
COST-VOLUME-PROFIT ANALYSIS
Alternative fixed cost structures - variable costs

The sensitivity analysis based on the CVP model highlights the risks and potential benefits of replacing fixed costs in the cost
structure of a company with variable cost.

CVP analysis can help managers to evaluate different structures of fixed-variable costs.

For renting the booth at the exhibition, the company pays $2,000. Let's say the exhibition organizer, Computer Conventions
offers three options for paying the rent:

• Option 1:fixed rate of $2,000

• Option 2: fixed rate of $800, plus 15% of revenue

• Option 3:25% of revenue, no fixed rate

 Using cost-volume-profit analysis
to plan variable and fixed costs
...comparison of risk to bear losses with the likelihood of obtaining higher benefits.

Operational leverage (ELO) is specific to a given level of sales, taken as a starting point. If the starting point changes, then the ELO will also change. For example, if the starting point is 50
units of sale, then the ELO for option 1 will be calculated as follows:
Operational leverage (OL) is specific to a given level of sales, taken as a starting point. If the starting point
changes, then the OL will also change. For example, if the starting point is 50 units of sale, then the OL for
option 1 will be calculated as follows:
MC = 80$ X 50 = 2.00
MC-FC (80$ X 50)-2000$
Option1 Option2 Option3

1. Marginal unitary contribution $ 80 $ 50 $ 30

2. Marginal contribution (row 1 x 40 units) $3200 $2000 $1200
3. Operational profit $1200 $1200 $1200
4. Operational leverage $3200 = 2.67 $2000 = 1.67 $1200 = 1.00
$1200 $1200 $1200
 In the CVP analysis, it is always assumed that a
Effect of the cost is either variable or fixed. But the variable
or fixed nature of a cost depends on the time
time horizon taken into account in the decision-making
process.
Influence of the cost structure in order
to manage the risk-profitability ratio
The accumulation of too high fixed costs could be dangerous for the economic health of Enterprises.
Because fixed costs, as opposed to variable costs, do not automatically decrease when production
volume decreases, companies with too high fixed costs may experience considerable losses during
periods of reduction of economic activity.
 EFFECTS OF THE STRUCTURE
OF SALES ON THE PROFIT
Do-All Superwood Total

Number of units sold 60 40 100

Revenue, $200 and $100 per unit $12000 $4000 $16000
Variable costs, $120 and $70 per unit 7200 2800 10000
Marginal contribution, $80 and $30 per unit $4800 $1200 6000
Fixed costs 4500
Operating profit $1500
 Revenue - Variable Costs - Fixed Costs = Operating Profit = 0

Where

Revenue= (Do-All Sale Price X Do-All Units Sold) +( Superwood Sale Price X Superwood Units Sold)

= 200$/unit X 3 S units + 100$/unit X 2 S units

= 600$ S + 200$S

= 800$ S

Variable Costs = (Unit Variable cost Do- All X Do-All Units Sold) + ( Unit Variable cost Superwood X Superwood Units Sold)

= 120$/unit X 3 S units + 70$/unit X 2 S units

= 360$ S + 140$S

= 500$ S
To calculate the break-even point, we have:

Revenue-Variable Costs-Fixed Costs=0

$800 S-$500 S-$4,500 =0
$800 S-$500 S=$4,500
$300 S=$4,500
S=15 units

To understand the concept of product structure, imagine

Number of Do-All units for
reach the break-even point =3S=3x15=45 units
Number of Superwood units for
reach the break-even point =2 S=2x 15=30 units
that software is only marketed on packages of 5 units: 3
of Do-All and 2 of Superwood. Imagining such a market,
"on packages" is useful for understanding the concept of
sales structure, even if in reality the marketing method
could be completely different.
Marginal unit contribution by weighted average method = (CMU Do-All X Do-All Units Sold)+( CMU Superwood X Superwood Units Sold)
Do-All Units Sold + Superwood Units Sold

= ( 80$ X 60) + (30$X 40) = 6000 $ = 60$

60 + 40 100
Under these conditions, we have:

Profitability threshold = Fixed costs = 4500$ = 75 units

Marginal unit contribution by weighted average method 60$

Because the ratio of Unit Sales to Do-All and Unit Sales of Superwood is 60:40 or 3:2, the break-even point is 45 (0.60x75) units of Do-All
and 30 (0.40 x75) units of Superwood.
In the multi-product situation, the break-even point expressed in terms of income can be calculated and using the percentage marginal
contribution by the weighted die, as follows:

Marginal unit contribution by weighted average method = Total marginal contribution = 6000$ = 0.375 or 37.5%
Total revenue 16000$
Total revenue required to reach the break-even point = Fixed costs = 4500$ = 12.000 $
Marginal unit contribution by weighted average method 0.375
Do All 54 48 42 36 30 24 18 12 6 0
Superwood 6 22 38 54 70 86 102 118 134 150
Total 60 70 80 90 100 110 120 130 140 150

Companies that sell more products adjust their product structure to meet changes in demand.
For example, as the price of gasoline rises and customers want smaller cars, car manufacturers
change their production structure to manufacture more small cars.
CVP ANALYSIS IN COMPANIES SERVICE
PRESTATORS AND ORGANIZATIONS
WITHOUT WORK SCOPE
Domain Measurement unit production
Airlines Mile-passenger
Hotels/Motels Nights-room occupied
Hospitals Patient days
Universities Student-credit hours
 MULTIPLES COST
DETERMINANTS
Operating profit= Income - ( Cost of each Do-All set X Number of sets) - ( Cost of documenting per customer X Number of clients) - Fixed costs

If Mary sells 40 sets of programs to 15 clients, then:

Operating profit= (200$/set x 40 sets)-(120$/set x 40 sets)

－（10$/client x 15 clients)-2.000$
＝8.000$-4.800$-150$-2.000$=1.050$

If Mary sells 40 sets of programs to 40 clients, then:

Operating profit= (200$ x 40)-(120$x40)-(10$x40)-2.000$

＝8.000$-4.800$-400$-2.000$=800$
COMPARATION BETWEEN MARGINAL
CONTRIBUTION AND GROSS MARGIN
In the commercial sector, the cost of goods sold consists of the cost of goods bought, then resold. In
the manufacturing sector, the cost of the goods produced consists entirely of production costs
(including fixed production costs). The expression "all variable costs" refers to the variable costs in
each economic function of the value chain.

Service companies can calculate the marginal contribution, but not the gross margin. This is due the
fact that, in the service sector, companies do not have a line dedicated to calculating the cost of goods
sold in the Results Account.
Account of results from management accounting, Account of financial accounting results,
with focus on marginal contribution with a focus on gross margin

Income $200 Income $200

Variable cost of goods sold $120 Cost of goods sold 120

Variable operating expenses 43 163

Marginal contribution 37 Gross margin 80

Fixed operating expenses 19 Operating expenses ($43 +$19) 62

Operating profit $18 Operating profit $18

 The main difference between the marginal
contribution and the gross margin for
companies in the commercial sector concerns
variable cost items that are not included in the
cost of goods sold. An example of such
Commercial variable cost item is the commissions paid to
sector commercial agents and calculated as a
percentage of revenue. The marginal
contribution is calculated by deducting all
variable costs from income, gross margin is
calculated by only deducting the cost of goods
being paid from income.
Productive sector
In the case of companies in the production sector, there are two
differences between the marginal contribution and the gross
margin: one related to fixed production costs and one related to
variable production costs.
 Results account with a focus on Results account with a focus on
marginal contribution gross margin

Income $1000 Income $1000

Variable cost of production $250 Cost of goods sold

Non-production variable costs 270 520 (250$+160$) 410

Marginal contribution 480 Gross margin 590

Fixed production costs 160 Non-production expenses

Fixed costs outside the production 138 298 ($270 +$138) 408

Operating profit $182 Operating profit $182