Cost-Volume-Profit

Analysis
 Cost-Volume-Profit (CVP) Analysis

◉ Examines the behavior of total revenues, total costs, and operating

income as changes occur in the output level, selling price, variable costs,
or fixed costs
◉ The analysis pertaining to the determination of the effects of changes in
volume on revenue, costs, and profit. It provides management with a
desired tool in the performance of its planning function since estimates of
revenue, cost and profit (or loss) can be readily made at different levels of
activity

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 CVP Analysis Assumptions

1. Total costs can be divided into a fixed component and a component that is
variable with respect to the level of output
2. The behavior of total revenues and total costs is linear in relation to output units
within the relevant range
3. The unit selling price, unit variable costs, and fixed costs are known
4. The analysis either covers a single product or assumes that a given revenue mix
of products will remain constant as the level of total units sold changes
5. All revenues and costs can be added and compared without taking into account
the time value of money

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 The Breakeven Point

The breakeven point is the quantity of output where total revenues and total costs are
equal, that is, where the operating income is zero. There is no profit nor loss
recognized or experienced.
1. Equation Method (Algebraic Approach)
○ Operating Income = Total Revenue - Total Costs
○ Operating Income = Total Revenue – Total Variable Costs – Total Fixed Costs
○ Total Revenue = Unit Selling Price x Quantity
○ Total Variable Costs = Unit Variable Costs x Quantity
OI = (USP x Q) – (UVC x Q) – TFC
At breakeven point, operating income is, by definition, zero. Setting OI = 0, we obtain
Breakeven number of units = QBE = TFC/(USP – UVC)

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 The Breakeven Point

2. Contribution Margin Method

○ Operating Income = Total Revenue – Total Variable Costs – Total Fixed Costs
○ OI = (USP - UVC) x Q - TFC
○ OI + TFC = (USP - UVC) x Q
○ OI + TFC = UCM x Q
Q = (OI + TFC)/UCM
At breakeven point, OI = 0
QBE = TFC/UCM
3. Graph Method
○ The breakeven point is the intersection between the total costs (total variable and fixed
costs) line and the total revenue line

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 The Breakeven Point

Illustrative Problem #1:

Given:
◉ Total Fixed Costs = $6,000 per month
◉ Unit Selling Price = $0.50/unit
◉ Unit Variable Costs = $0.40/unit

Required: Compute for breakeven point in units and in sales

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 The Breakeven Point

If Target Operating Income is Specified:

◉ Let QT = Number of unit sold to earn target operating income
◉ Target Operating Income = Total Revenue – Total Variable Costs – Total Fixed Costs
◉ QT = (Total Fixed Costs + Target Operating Income)/Unit Contribution Margin
◉ QT = (TFC + TOI)/UCM
If Target Net Income is Specified:
◉ Target Net Income After Tax = Operating Income – Operating Income (Tax Rate)
◉ Target Net Income After Tax = Operating Income (1 - Tax Rate)
◉ Operating Income = Target Net Income After Tax / (1 - Tax Rate)

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 The Breakeven Point

Illustrative Problem #2:

Given: Total Fixed Costs = $100,000 per year; Selling Price/Ticket = $50; Variable Costs/Ticket
= $30
Required:
a) Find breakeven point in units and in sales
b) It was suggested that selling price is increased by 10%, total fixed costs lowered by 20%,
and variable costs increased by 15%, find the new breakeven point in units and in sales.
c) Find the required number of units to be sold if
i. A target profit of 10% of sales should be realized
ii. A net income after tax of P100 is desired. Assume a 40% tax rate

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 Sensitivity Analysis and Uncertainty

◉ Margin of Safety (M/S) – excess of budgeted revenues over

the breakeven revenues. It answers the what-if question: If
budgeted revenues are above breakeven and drop, how far
can they fall below budget before the breakeven point is
reached?

M/S = (Sales Revenue – Breakeven Point in Sales)/Sales Revenue

M/S = (Units Sold – Breakeven Point in Units)/Units Sold

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 Multi-Product Breakeven Analysis

◉ Using Weighted Contribution Margin (WCM):

WCM = CM1(%SV1) + CM2(%SV2) + CM3(%SV3) + . . . +

CMn(%SVn)
Where: CM = contribution margin
SV = sales volume (in units)
n = number of products

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BEP (units) = TFC/WCM
 Multi-Product Breakeven Analysis

◉ Using Weighted Contribution Margin Ratio (WCMR):

WCMR = CMR1(%SR1) + CMR2(%SR2) + CMR3(%SR3) + . . . +

CMRn(%SRn)
Where: CMR = contribution margin ratio
SR = sales revenue
n = number of products

BEP = TFC/WCMR
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 Multi-Product Breakeven Analysis

Illustrative Problem #3:

Given:

Product X Y Z Total
Selling Price (PhP) 10 / unit 6 / unit 5 / unit
Variable Cost (PhP) 6 / unit 4 / unit 2 / unit
Fixed Cost (PhP) 500,000
Sales Volume 100,000 200,000 300,000 600,000
(units)

Required: Compute for the breakeven point in units for products X, Y, and Z

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 Non-Linear Breakeven Analysis

◉ When demand becomes a function of selling price

◉ D = dependent variable, p = independent variable

p = a – bD

Where p = selling price, D = demand volume, a&b = constants

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 Non-Linear Breakeven Analysis

◉ To compute for demand that will maximize sales revenue:

◉ To compute for demand that will maximize total profit:

◉ To compute for breakeven demand (2 values):

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 Sample Problems

1. A company produces and sells a consumer product, and thus far has been able to
control the volume of the product by varying the selling price. The company is
seeking to maximize its net profit. It has been concluded that the relationship
between price and demand per month is approximately D = 500-5p, where p is the
price per unit in dollars. The fixed cost is $1,000 per month, and the variable cost
is $20 per unit.
a) What is the optimal no. of units that should be produced and sold per month?
b) What is the maximum profit per month?
c) What are the breakeven sales quantities (or range of profitable demand)?

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 Sample Problems

2. A company produces an electronic timing switch that is used in consumer and

commercial products made by several other manufacturing firms. The fixed cost
is $73,000 per month, and the variable cost is $83 per unit. The selling price per
unit is p=$180-0.02D. Determine:
(a) the optimal volume for this product and confirm that a profit occurs at this
demand, and
(b) find the volumes at which breakeven occurs.

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 Sample Problems

3. A municipal solid waste site must be located outside Anytown or Yourtown. After sorting,
some of the solid refuse will be transported to an electric power plant where it will be used as
fuel. Data for the hauling of refuse from each town to the power plant is shown below:

Anytown Yourtown
Average hauling distance 4 miles 3 miles
Annual rental fee for solid waste site $ 5,000 $ 100,000
a. If the power plant Hauling
will pay cost$ 8.00 per
cubic yard of /sorted
$ 1.50 cu. yd. -solid
waste mile delivered to- mile
$ 1.50 / cu. yd the plant,
where should the solid waste site be located? Use the town’s viewpoint and assume that
200,000 cubic yards of refuse will be hauled to the plant for one year only. One site must be
selected.

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 Sample Problems

3. A municipal solid waste site must be located outside Anytown or Yourtown. After sorting,
some of the solid refuse will be transported to an electric power plant where it will be used as
fuel. Data for the hauling of refuse from each town to the power plant is shown below:

Anytown Yourtown
Average hauling distance 4 miles 3 miles
Annual rental fee for solid waste site $ 5,000 $ 100,000
b. Hauling cost
Referring to the electric power plant above, $the
1.50 /cost
cu. yd.Y- mile
in dollars $per
1.50 hour
/ cu. ydto
- mile
produce
electricity is Y = 12 + 0.2X + 0.27X 2 , where X is in megawatts. Revenue in dollars per hour
from the sale of electricity is 16X - 0.2X 2. Find the value of X that gives the maximum
profit.

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