Study Unit 2

COST-VOLUME-PROFIT ANALYSIS
 Study outcomes
 On completion of this study unit you
should be able to:
 Describe and apply the following concepts and
to calculate each of them:
 Break-even point
 Contribution(marginal income/contribution margin)
 Contribution margin ratio
 Margin of safety
 Margin of safety ratio
 Operating leverage
 … Study outcomes
 On completion of this study unit you should be
able to:
 Discuss the assumptions of the break-even analysis
and outline its implications.
 Compute the expected turnover (sales) for a target
profit before and after tax.
 Apply the cost-volume-profit analysis in organisations.
 Construct the following graphs and compute figures
by way of the following graphs:
 Conventional break-even graph (cost-volume-profit graph)
 Contribution graph
 Profit - volume graph
 … Study outcomes
 Discuss the critique against break-even
analysis.
 Make diversions when any of the
assumptions of cost-volume-profit analysis
are not realised.
 1. Introduction
 Decision making is a very important factor at
any organisation and a study of the relationship
between cost, volume and profit can help in this
regard.
 Examples of problems that can be solved:
 Determination of selling price (SP) at break-even
point (BEP)
 Determination of SP that represents a specific %
return on capital
 Determination of the sales volume that will give a
certain turnover
 Impact of increase in sales on profit
 Test your knowledge…
Per unit
Sales price 100
Material 30
Labour 20
Variable overheads 10
Fixed overheads 20
Profit per unit 20

What is the profit for 100, 200 and

300 units respectively?
We normally sell 200 units.
 Test your knowledge…
Per unit
Sales price 100
Material 30
Labour 20
Variable overheads 10
Fixed overheads 20
Profit per unit 20

What is the profit for 100, 200 and 300 units respectively?

Sales units 100 200 300

Sales 10 000 20 000 30 000
Material 3 000 6 000 9 000
Labour 2 000 4 000 6 000
Variable overheads 1 000 2 000 3 000
Contribution 4 000 8 000 12 000
Fixed overheads 4 000 4 000 4 000
Profit - 4 000 8 000

NOT 2 000 4 000 6 000

 Concept of contribution

 Gross profit vs. contribution

 Should not make decisions where fixed
costs are used on a per unit basis
 Costs should be separated between
variable and fixed costs for decision
making and planning purposes
 Concept of contribution
 What is gross profit?
Sales
Less Cost of sales
Material
Labour
Variable overheads
Fixed overheads
Gross profit
Less Sales and admin
Sales cost
Admin
Profit
 Concept of contribution
 What is contribution?
Sales
Less Variable cost
Material
Labour
Variable overheads
Variable sales costs
Contribution
Less Fixed cost
Fixed overheads
Fixed admin
Profit
 Concept of contribution

 Variable cost vary in direct proportion to

the volume of activity
 Total variable costs are linear and
 Unit variable cost is constant
 Fixed costs remain constant over wide
ranges of activity for a specified period
 Total fixed costs are constant for all levels of
activity,
 Whereas unit fixed costs decrease
proportionally with the level of activity
 Mixed costs include both a fixed and a
variable component – should be separated
 Total variable cost
Total material cost is based on number
of units produced.
Total material cost

Units produced
 Variable cost per unit

The cost per unit is constant.

Cost per unit

Units produced
 Total fixed cost
The monthly salaries don't change if
you produce more units.
Monthly salaries

Units produced
 Fixed cost per unit
The average cost per unit reduces if
more units are produced.
Monthly salaries cost per
unit produced

Number of units
 Total mixed cost
Portion of electricity not impacted by
production, portion changes the more
units produced.
Total electricity cost

Units produced
 Concept of contribution

 Gross profit vs. contribution

 Should not make decisions where fixed
costs are used on a per unit basis
 Costs should be separated between
variable and fixed costs for decision
making and planning purposes
 2. Terminology
 Contribution (marginal income)
Sales less variable costs; remaining amount
available to cover fixed costs and result in
profit
 Contribution margin
Contribution expressed as a percentage of sales
 Break-even point
Point where there is no profit or loss
 Class example
 Estimated fixed costs are R60 000.
 Catering costs is R10 per person.
 Proposed sales price of ticket is R20

 Number of tickets to break-even?

 Class example
 Estimated fixed costs are R60 000.
 Catering costs is R10 per person.
 Proposed sales price of ticket is R20

 How many tickets must be sold to earn

R30 000 profit?
 Class example
 Estimated fixed costs are R60 000.
 Catering costs is R10 per person.
 Proposed sales price of ticket is R20

 Profit if 8 000 tickets were sold?

 Class example
 Estimated fixed costs are R60 000.
 Catering costs is R10 per person.
 Proposed sales price of ticket is R20

 Selling price to be charged to give a profit

of R30 000 on sales of 8 000 tickets, fixed
costs of R60 000 and variable costs of R10
per ticket?
 Class example
 Estimated fixed costs are R60 000.
 Catering costs is R10 per person.
 Proposed sales price of ticket is R20

 How many additional tickets must be sold

to cover the extra cost of television
advertising of R8 000?
 3. Break-even point
 The break-even point is the level of sales
where the profit is zero (rand or units)
 Three methods:
 Equation method
 Contribution method
 Graph method
 3. Break-even point
 Equation method
Sales = variable costs + fixed
cost + profit
Thus at the break-even point the profit is zero and
the equation as follows:
Sales = variable costs + fixed
costs + 0
To get units:
SP X = VC X + FC + 0
(SP X – VC X) = FC
X(SP – VC) = FC
X = FC / (SP – VC)
 3. Break-even point
 Contribution method
Derived from equation method

Break-even point (units) = Fixed costs

Contribution/unit