CHAPTER 9

COST-VOLUME-PROFIT
ANALYSIS
COST-VOLUME-PROFIT ANALYSIS
 Cost volume profit analysis is a systematic
method of examining the relationship between
selling price, total sales revenue, volume of
production, expenses and profit.
 It can be used in
 setting selling prices,
 selecting the products mix to sell,
 choosing among alternative marketing strategies
and
 analyzing the effects of cost increase or decrease
on the profitability of the business enterprise.
Factors affecting the level of
profits
 Among the factors which influence the level of

profits, the following are considered as key

factors:
 Selling price

 Volume of sales

 Variable costs on per unit

 Total fixed cost and

 Sales mix (the proportions or combination in

which different products are sold)

Techniques of CVP analysis

 To answer the following questions, different

CVP techniques are used.
 How much must I sell to earn my desired income?
 How will income be affected if I reduce selling prices
to increase sales volume?

 What will happen to profitability if I expand

capacity? etc
 Different Techniques of CVP analysis
are
1. Contribution Margin
2. Break-Even Analysis and
3. Profit-volume (p/v) Analysis
 In CVP analysis all expenses are classified
into fixed and variable expenses.
 Semi-variable expenses have to be divided
into their fixed and variable elements.
Total Fixed Cost

Total fixed costs remain unchanged

when activity changes.
Total fixed costs

Your total fixed cost probably

does not change when
you use more units.

Number of units
Fixed Cost Per Unit
Fixed costs per unit decline
as activity increases.

Your average cost per Total fixed cost

unit decreases as
more units are used.
Number of units
Total Variable Cost

Total variable costs change

when activity changes.
Cost per unit

Your total cost is based

on how many units
you are used.

unit
 Variable Cost Per Unit

Variable costs per unit do not change

as activity increases.

Charge
Per unit
The cost per unit is constant.

units
 Cost Behavior Summary

Summary of Variable and Fixed Cost Behavior

Cost In Total Per Unit

Changes as activity level Remains the same over wide

Variable
changes. ranges of activity.
Remains the same even Dereases as activity level
Fixed
when activity level changes. increases.
 Mixed Costs

 Mixed costs contain a fixed portion that is incurred

even when facility is unused, and a variable
portion that increases with usage.

Example: monthly electric utility charge

 Fixed service fee
 Variable charge per
kilowatt used
Mixed Costs
Slope is
variable cost
per unit
of activity.
Total Utility Cost

ost
d c
i xe Variable
l m
ta Utility Charge
To

Fixed Monthly
Utility Charge
Activity (Kilowatt Hours)
Stair-Step Costs

Total cost remains

constant within a
narrow range of
activity.

Cost
Activity
Stair-Step Costs

Total cost increases to a

new higher cost for the
next higher range of
activity.

Cost
Activity
Contribution Margin Concept
 Contribution margin concept indicates the profit
potential of a business enterprise and also
highlights the relationship between cost, sales and
profit.
 Contribution margin is the excess of sales
revenue over variables costs
(under contribution concept variable cost includes all
variable production and selling costs)
Formula to calculate contribution margin ratio is

sales  var iable cos t

sales
Example:
 Assume the following information in case a company
sales $100,000
Variable costs 60,000
Fixed costs 30,000
A. How much is the contribution margin?
Contribution margin = sales – variable costs
= 100,000 – 60,000
= 40,000
Profit = contribution margin – Fixed cost
= 40,000 – 30,000
= 10,000
 B. Contribution margin ratio

Contribution margin ratio =

sales  var iable cos t
sales

100,000  60,000
100,000

= 40%
 P/v ratio( contribution margin ratio) helps to know the
effect of a firm due to an increase or decrease in
volume of sales.
 For example, taking the previous example and if the
enterprise has an interest to increase its sales by
$40,000, what will be the profit?
Sales (100, 000 + 40,000) $140,000
Less: Variable cost (140, 000 x 60%) 84,000
Contribution margin (140, 000 x 40%) 56,000
Less: Fixed cost 30,000
Profit 26,000
Computing Break-Even Point

The break-even point (expressed in units of

product or dollars of sales) is the unique
sales level at which a company neither earns
a profit nor incurs a loss.
Computing Break-Even Point

Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

Contribution
Contributionmargin
margin is
isamount
amount by
bywhich
whichrevenue
revenue
exceeds
exceedsthe
thevariable
variablecosts
costsof
ofproducing
producing the
therevenue.
revenue.
Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How
Howmuch
much contribution
contributionmargin
marginmust
must this
thiscompany
company
have
haveto
tocover
coverits
itsfixed
fixed costs
costs(break
(breakeven)?
even)?
Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How
Howmuch
much contribution
contributionmargin
marginmust
must this
thiscompany
company
have
haveto
tocover
coverits
itsfixed
fixed costs
costs(break
(breakeven)?
even)?
Answer:
Answer: $30,000
$30,000
Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How
Howmany
many units
units must
mustthis
thiscompany
companysell
sellto
tocover
coverits
its
fixed
fixedcosts
costs(break
(breakeven)?
even)?
Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How
Howmany
many units
units must
mustthis
thiscompany
companysell
sellto
tocover
coverits
its
fixed
fixedcosts
costs(break
(breakeven)?
even)?
Answer:
Answer: $30,000
$30,000÷÷$20
$20per
perunit
unit == 1,500
1,500units
units
 Formula for Computing
Break-Even Sales (in Units)
Finding the Break-Even Point
We have just seen one of the basic CVP
relationships – the break-even computation.
Fixed costs
Break-even point in units =
Contribution margin per unit

Unit sales price less unit variable cost

($20 in previous example)
Formula for Computing
Break-Even Sales (in Dollars)
The break-even formula may also be
expressed in sales dollars.

Fixed costs
Break-even point in dollars =
Contribution margin ratio

Unit sales price-unit variable cost

Formula for Computing
Break-Even Sales (in Dollars)
The break-even formula may also be
expressed in sales dollars.

Fixed costs
Break-even point in dollars =
Contribution margin ratio

Unit sales price - unit variable cost

Unit sales price
Computing Break-Even Sales
Question 1
ABC
ABC Co.
Co. sells
sells product
product XYZ
XYZ at
at $5.00
$5.00 per
per unit.
unit. IfIf fixed
fixed
costs
costs are
are $200,000
$200,000 and
and variable
variable costs
costs are
are $3.00
$3.00 per per
unit,
unit, how
how many
many units
units must
must be
be sold
sold to
to break
break even?
even?

a.
a. 100,000
100,000 units
units
b.
b. 40,000
40,000 units
units
c.
c. 200,000
200,000 units
units
d.
d. 66,667
66,667 units
units
Computing
Computing Break-Even
Break-Even Sales
Sales
Question
Question 11
ABC
ABC Co.
Co. sells
sells product
product XYZ
XYZ at
at $5.00
$5.00 per
per unit.
unit. IfIf fixed
fixed
costs
costs are
are $200,000
$200,000 and
and variable
variable costs
costs are
are $3.00
$3.00 per per
unit,
unit, how
how many
many units
units must
must be
be sold
sold to
to break
break even?
even?

a.
a. 100,000
100,000 units
units
b.
b. 40,000
40,000 units
units
c.
c. 200,000
200,000 units
units
Unit contribution = $5.00 - $3.00 = $2.00
d.
d. 66,667
66,667 units
unitsFixed costs $200,000
= $2.00 per unit
Unit contribution
= 100,000 units
Computing
Computing Break-Even
Break-Even Sales
Sales
Question
Question 22
Use
Use thethe contribution
contribution margin
margin ratio
ratio formula
formula toto
determine
determine the the amount
amount of
of sales
sales revenue
revenue ABCABC must
must
have
have to to break
break even.
even. All All information
information remains
remains
unchanged:
unchanged: fixed fixed costs
costs are
are $200,000;
$200,000; unit
unit sales
sales
price
price is
is $5.00;
$5.00; and
and unit
unit variable
variable cost
cost isis $3.00.
$3.00.

a.
a. $200,000
$200,000
b.
b. $300,000
$300,000
c.
c. $400,000
$400,000
d.
d. $500,000
$500,000
Computing
Computing Break-Even
Break-Even Sales
Sales
Question
Question 22
Use
Use the
the contribution
contribution margin
margin ratio
ratio formula
formula toto
determine
determine the the amount
amount ofof sales
sales revenue
revenue ABC ABC must
must
have
have to to break
break even.
even. All
All information
information remains
remains
unchanged:
unchanged: fixedfixed costs
costs are
are $200,000;
$200,000; unitunit sales
sales
price
price is
is $5.00;
$5.00; and
and unit
unit variable
variable cost
cost isis $3.00.
$3.00.
Unit contribution = $5.00 - $3.00 = $2.00
a.
a. $200,000
$200,000
Contribution margin ratio = $2.00 ÷ $5.00 = .40
b.
b. $300,000
$300,000
Break-even revenue = $200,000 ÷ .4 = $500,000
c.
c. $400,000
$400,000
d.
d. $500,000
$500,000
Preparing a CVP Graph
 Starting at the origin, draw the total revenue
line with a slope equal to the unit sales price. Revenue
Costs and Revenue
in Dollars

 Total fixed cost

extends horizontally
from the vertical axis.

Total fixed cost

Volume in Units
Preparing a CVP Graph

 Draw the total cost line with a slope

equal to the unit variable cost. Revenue
Costs and Revenue

Break-even
Profit
Point
in Dollars

Total cost

Loss
Total fixed cost

Volume in Units
Computing Sales Needed to Achieve
Target Operating Income
Break-even
Break-even formulas
formulas may
may be
be adjusted
adjusted toto show
show
the
the sales
sales volume
volume needed
needed to to earn
earn
any
any amount
amount of
of operating
operating income.
income.

Fixed costs + Target income

Unit sales =
Contribution margin per unit

Fixed costs + Target income

Dollar sales =
Contribution margin ratio
Computing Sales Needed to Achieve
Target Operating Income
ABC
ABC Co.
Co. sells
sells product
product XYZ
XYZ at
at $5.00
$5.00 per
per unit.
unit. IfIf
fixed
fixed costs
costs are
are $200,000
$200,000 and
and variable
variable costs
costs
are
are $3.00
$3.00 per
per unit,
unit, how
how many
many units
units must
must bebe
sold
sold to
to earn
earn operating
operating income
income ofof $40,000?
$40,000?

a.
a. 100,000
100,000 units
units
b.
b. 120,000
120,000 units
units
c.
c. 80,000
80,000 units
units
d.
d. 200,000
200,000 units
units
Computing Sales Needed to Achieve
Target Operating Income
ABC
ABC Co.
Co. sells
sells product
product XYZ
XYZ at
at $5.00
$5.00 per
per unit.
unit. IfIf
fixed
fixed costs
costs are
are $200,000
$200,000 and
and variable
variable costs
costs
are
are $3.00
$3.00 per
per unit,
unit, how
how many
many units
units must
must bebe
sold
sold to
to earn
earn operating
operating income
income ofof $40,000?
$40,000?

Unit contribution = $5.00 - $3.00 = $2.00

a.
a. 100,000 units
100,000 units
Fixed costs + Target income
b.
b. 120,000 units
120,000 units Unit contribution
c.
c. 80,000
80,000 units
units
$200,000 + $40,000
= 120,000 units
d.
d. 200,000 units
200,000 units $2.00 per unit
What is our Margin of Safety?

Margin of safety is the amount by which sales may

decline before reaching break-even sales:

Margin of safety = Actual sales - Break-even sales

Margin of safety provides a quick means of estimating

operating income at any level of sales:

Operating Margin Contribution

Income = of safety × margin ratio
 What is our Margin of Safety?
ABC’s contribution margin ratio is 40 percent. If
sales are $100,000 and break-even sales are
$80,000, what is operating income?

Operating Margin Contribution

Income = of safety × margin ratio

Operating
Income = $20,000 × .40 = $8,000
 What Change in Operating Income
Do We Anticipate?
Once break-even is reached, every additional dollar of
contribution margin becomes operating income:

Change in Change in Contribution

operating income = sales volume × margin ratio

ABC expects sales to increase by $15,000. How much will

operating income increase?

Change in
operating income = $15,000 × .40 = $6,000
Business Applications of CVP
Business Applications of CVP

Consider the following information developed by

the accountant at Cycle Co, a bicycle retailer:

Total Per Unit Percent

Sales (500 bikes) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
Operating income $ 20,000
Business Applications of CVP

Should CyclCo spend $12,000 on advertising to

increase sales by 10 percent?

Total Per Unit Percent

Sales (500 bikes) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
Operating income $ 20,000
Business Applications of CVP

Should Cycle Co spend $12,000 on advertising

to increase sales by 10 percent?
500 550
Bikes 550 × $500 Bikes
Sales $ 250,000 $ 275,000
Less: variable expenses 150,000 165,000
550 × $300
Contribution margin $ 100,000 $ 110,000
Less: fixed expenses 80,000 92,000
Operating income $ 20,000 $80000 + $12000$ 18,000

No, income is decreased.

Business Applications of CVP
Now, in combination with the advertising,
Cycle Co is considering a 10 percent price reduction that will
increase sales by 25 percent. What is the income effect?
500
Bikes
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin $ 100,000
Less: fixed expenses 80,000
Operating income $ 20,000
Business Applications of CVP
Now, in combination with the advertising,
CyclCo is considering a 10 percent price reduction that will
increase sales by 25 percent. What is the income effect?
500 1.25 × 500 625
Bikes Bikes
Sales $ 250,000 625 × $450 $ 281,250
Less: variable expenses 150,000 187,500
Contribution margin $ 100,000 625 × $300 $ 93,750
Less: fixed expenses 80,000 92,000
Operating income $ 20,000$80000 + $12000 $ 1,750

Income is decreased even more.

 Business Applications of CVP
Now, in combination with advertising and a price cut, Cycle Co
will replace $50,000 in sales salaries with a $25 per bike
commission, increasing sales by 50 percent above the
original 500 bikes. What is the effect on income?
500
Bikes
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin $ 100,000
Less: fixed expenses 80,000
Operating income $ 20,000
 Business Applications of CVP
Now, in combination with advertising and a price cut, Cycle Co
will replace $50,000 in sales salaries with a $25 per bike
commission, increasing sales by 50 percent above the
original 500 bikes. What is the effect on income?
500 750
1.5 × 500
Bikes Bikes
Sales $ 250,000 750 × $450 $ 337,500
Less: variable expenses 150,000 243,750
Contribution margin $ 100,000 750 × $325 $ 93,750
Less: fixed expenses 80,000 42,000
Operating income $ 20,000 $92000 - $50000 $ 51,750

The combination of advertising, a price cut,

and change in compensation increases income.
CVP Analysis When a Company
Sells Many Products
Sales
Sales mix
mix is
is the
the relative
relative combination
combination inin which
which
aa company’s
company’s different
different products
products are
are sold.
sold.
ItIt refers
refers to
to the
the ratio
ratio or
or relative
relative combination
combination of
of
each
each product’s
product’s sales
sales toto total
total sales.
sales.
Different
Different products
products have
have different
different selling
selling prices,
prices,
costs,
costs, and
and contribution
contribution margins.
margins.
 Sales mix is the composition of total sales broken
down among various products or product lines.
 Example: A company has three products labeled as
Model X, Model Y and Model Z. Sales on monthly
basis are expected to be as follows:
Model X Model Y Model Z Total

Unit 1,000 1,500 2,500 5,000

Sales ratio 20% 30% 50% 100%
 This means that for every 2 units of model x that are sold,
there are 3 units of model y and 5 units of model z. Or
 Multi products would have 2 units model x, 3 units model y
and 5 units model z, for a total of 10 units
Example:
 A company has three sales ratio of 2:3:5 for model x,
model y and model z. Total fixed costs for the month are
$200,000. The sales price, variable costs and
contribution margin associated with each product are as
follows:

Model X Model Y Model Z

Sales prices $50 $25 $10
 Variable costs 30 15 8
 Contribution margin 20 10 2

How much is the total contribution margin of the average market basket
(consists of 10 units) based on the sales ratio?
Solution:

 The total contribution of the average market

basket is based on the sales ratio and
consists of 10 units
 = (2 x $20) + (3 x $10) + (5 x $2)
 = $80
How much is the break even point in the
market basket?
 The break even point in the market basket is
computed using the break even point formula:-
$200000

$80
 2500units
In order to fill 2,500 baskets, it will take the following amounts for each model:
Model x 500 units which is 2,500 units X 2/10
Model y 750 units 2,500 units X 3/10
Model z 1250 units 2,500 units X 5/10
This is the break even point for each model as long as the sales mix stays at
2:3:5
How much is the Break even point3 in
x $25 = $75
sales? 3 x $15 = $45
5 x $10 = $50
 Calculate the contribution margin ratio 5 x $8 = $40
Solution:
Model X Model Y Model Z Total

Sales price 2 x $50 = $100 $100 $75 $50 $225

Variable cost 2 x $30 = $60 $60 $45 $40 $145
Contribution Margin $40 $30 $10 $80

Contribution margin ratio = ($80 ÷ 225) x 100

= 35.555%
Then, Break even point in sales = ($200,000 ÷ 35.555%)
= $562,500
 Example 2

Cycle Co provides us with the following

information:
Bikes Carts Total
Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Net income $ 95,000
 Compute contribution margin:

The overall contribution margin ratio is:

Bikes Carts Total

Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Net income $ 95,000

$265,000
= 48% (rounded)
$550,000
 Compute Break even point in Dollar
value.
Break-even in sales dollars is:

Bikes Carts Total

Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Operating income $ 95,000

$170,000
= $354,167 (rounded)
.48