CVP Analysis

Cost Volume Profit Analysis (CVP analysis)

 Also commonly referred to as Break Even Analysis,

 It is a way for companies to determine how changes in costs (both variable
and fixed) and sales volume affect a company’s profit.
 With this information, companies can better understand overall performance
by looking at how many units must be sold
 to break even, or
 to reach a certain profit threshold,
 or the margin of safety.
Example:
Assumptions for the Analysis
 Variable costs remain variable and fixed costs remain static at every level of
production.
 Sales volume does not affect the selling price of the product. We can assume
the selling price as constant.
 At all level of sales, the volume, material, and labor costs remain constant.
 Efficiency and productivity remains unchanged at all the levels of sales
volume.
 The sales-mix at all level of sales remains constant in a multi-product
situation.
 The relevant factor which affects the cost and revenue is volume only.
 The volume of sales is equal to the volume of production.
Components of CVP analysis
 There are several different components that together make up CVP analysis.
 These components involve various calculations and ratios.

 The main components of CVP analysis are:

 CM ratio and variable expense ratio
 Break-even point (in units or dollars)
 Margin of safety
 Changes in net income
 Degree of operating leverage
Contribution
 Contribution margin:
The difference between a company's total revenue and total variable costs.
It is the amount that sales contribute towards fixed costs and profit.

 Contribution margin per unit:

The difference between sales price and variable cost per unit.

 Contribution margin ratio:

The ratio of contribution margin to total revenue.
Marginal Cost Equation
 Equations for elements of cost are as follows:

 Sales = Variable costs + Fixed Expenses ± Profit /Loss

Or
 Sales – Variable Cost = Fixed Expenses ± Profit /Loss
Or
 Sales – Variable Cost = Contribution
CM Ratio and Variable Expense Ratio
 CM ratios and variable expense ratios are numbers that companies generally
want to see to get an idea of how significant variable costs are.

 CM Ratio = Contribution Margin / Sales

 
 Variable Expense Ratio = Total variable costs / Sales
 
 A high CM ratio and a low variable expense ratio indicate low levels of
variable costs incurred.
Profit-Volume Ratio

 Profit / Volume (P/V) ratio is calculated while studying the profitability of

operations of a business and to establish a relation between Sales and Contribution.

 The P/V Ratio shares a direct relation with profits. Higher the P/V ratio, more the
profit and vice-a-versa.
Break-Even Point

 Break-even point:
The sales volume (in units and dollars) at which the company is neither
making a loss nor earning any profit.

 The break-even point (BEP), in units, is the number of products the company
must sell to cover all production costs.
 Similarly, the break-even point in dollars is the amount of sales the company
must generate to cover all production costs.

 BEP = total fixed costs /  CM per unit

Break-Even Point

 Income Statement:

 BEP = total fixed costs /  CM per unit

 BEP = 240,000/15 = 16,000 units.
Therefore, if the company sells 16,000 units, the profit will be zero and the
company will “break even” and only cover its production costs.
Break-Even Point

 .

 Break-even point based on total sales:

 Calculation of output or sales value at which a desired profit is earned:

Composite Break Even Point

 A company may have different production units, where they may produce the
same product. In this case, the combined fixed cost of each productions unit
and the combined total sales are taken into consideration to find out BEP.

 Constant Product -
Mix Approach In this approach, the ratio is constant for the products of all
production units.

 Variable Product -
Mix Approach In this approach, the preference of products is based on bigger
ratio.
Margin of Safety

 The percentage (or Rupees) by which a company's sales volume exceeds its
break-even point.

 Excess of sale at BEP is known as margin of safety. 

 Margin of safety = Actual Sales − Sales at BEP

 .
Break-Even Chart

 CVP relationship can also be expressed in the form of a graph called CVP
graph
 Break-Even Chart is the most useful graphical representation of marginal
costing.
 It converts accounting data to a useful readable report.
 Estimated profits, losses, and costs can be determined at different levels of
production.
Break-Even Chart
Example: BEP
 Calculate break-even point and draw the break-even chart from the following data:
Fixed Cost = Rs 2,50,000
Variable Cost = Rs 15 per unit
Selling Price = Rs 25 per unit
Production level in units 12,000, 15,000, 20,000, 25,000, 30,000, and 40,000.
 Solution:

At production level of 25,000 units,

the total cost will be {(25000 × 14) + 2,50000} = Rs 6,25,000.
Example: BE chart
 Example: BE chart
1,200,000

1,000,000

800,000
Amount

Break Even Point

600,000

400,000

200,000

0
Production 12000 15000 20000 25000 30000 40000

Total Sale Total Cost Fixed Cost Variable Cost

Thank You
 Additional Reading:
 https://nptel.ac.in/content/storage2/nptel_data3/html/mhrd/ict/text/127105007/lec
28.pdf
 https://www.tutorialspoint.com/accounting_basics/cost_accounting_cvp_analysis.htm
 https://xplaind.com/612533/cvp-analysis
 https://corporatefinanceinstitute.com/resources/knowledge/finance/cvp-analysis-guid
e/

 Watch:
 https://www.youtube.com/watch?v=fdqVhqOcrmI