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## ( ID- 6002) (ID-6003) (ID- 6004) (ID- 6005)

Cost-Volume-Profit Analysis

Costs

Revenue

Presentation outline
Accounting Approach to Breakeven

Analysis. Single Product firm BEP Multi-product firm BEP Without constraint With many resource constraints Economic Approach to Breakeven Analysis. Cost Volume Profit Analysis under Uncertainty Discrete variable approach Continuous variable approach

## Concept of Cost-Volume Profit Analysis

A. B. C.

D.
E. F.

G.
H. I.

Concepts of CVP Cost-Volume-Profit Assumptions Concepts of BEP & CM CVP Equation Approach Contribution Margin Approach Graphical presentation Target profit Margin of Safety Limitations of CVP analysis

## What is Cost-Volume Profit Analysis?

Costvolume-profit analysis involves an examination of cost and revenue behavioral patterns and their relationships with profit. The analysis -- separates costs into fixed and variable components and determines the level of activity where costs and revenues are in equilibrium.

## Use CVP Analysis to

Compute the break-even point
Study interrelationships of

prices volumes fixed and variable costs contribution margins Profits Calculate the level of sales necessary to achieve a target profit Set sales price

## Selling price remains constant. Production

is equal to sales i.e. inventory level do not changes. Costs are linear throughout the entire relevant range and they can accurately be divided into variable and fixed elements. In multi-product companies, the sales mix is constant.

## Accounting approaches to BEP analysis

The CVP analysis also known as break even analysis, to compute the volume or level of activity for which the profit generated is zero (cost=revenue) and beyond which any increase in production will lead to a positive result or profit.

## Concepts of BEP &CM

Breakeven point:

Break-even point is the point in which the volume of activity where the organizations revenues and expenses are equal.BEP is the point where operating income equals zero.
Total revenues = Total costs

## Contribution Margin Ratio

Calculation of the break-even point in dollar rather than units by using the contribution margin ratio.

= CM Ratio

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## Methods of BEP analysis

In accounting approaches there are some methods of BEP

## CVP Equation Approach

Sales revenue Variable expenses Fixed expenses = Profit

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## In algebraic terms, profit or loss may be given by

= Pq-(F+Vq)
where, = Profit before tax P = Unit selling price=\$50 q = Sales volume in units=1000units V = Unit variable cost = \$30 F = Total fixed costs=\$10000 = 501000 (10000 +301000) =\$ 10000

## Breakeven computation in equation approach

Sales = variable cost +fixed cost +profit Q = quantity of unit sold Unit selling price = \$50 Unit variable cost = \$30 Fixed cost = \$10000 In the break even point , profit = \$o 50Q = 30Q +\$10000+\$0 Q = 10000/20 Q = 500 units BEP sales in dollar = 500units\$50 =\$ 25000

## Break Even Point by CM approach

BEP sales in units : q=F/P-V

Where, q=Break even volume P-V=Contribution margin F=fixed cost Calculation of BEP sales in units : If , Sales price per unit=\$ 50 Variable cost pr unit=\$ 30 Fixed cost =\$ 10000 Contribution margin per unit=\$ (50-30) =\$ 20 Break even sales in units, Y = 10000/20 = 500 units

BEP sales in dollar: y=F/ 1-P/V Where, y=Break even sales in dollar 1-P/V=Contribution margin ratio F=fixed cost Calculation of BEP sales in units : If , Sales price per unit=\$ 50 Variable cost pr unit=\$ 30 Fixed cost =\$ 10000 Contribution margin ratio=1-30/50 =0.40 Break even sales in dollar , y = 10000 /0.40 = \$25000

Breakeven Point
Sales Variable expenses = Fixed expenses

Proof
Sales Less : variable expense Contribution margin Less : fixed expense Net income \$ 25000 \$ 15000 \$ 10000 \$ 10000 ---

## BREAK EVEN CHART

Break even chart depicting the interactions between the cost and revenue structures .It shows the relationship between sales volume as an independent variable and the total cost as a dependent variable .
Break-even chart illustrates relationships among Revenue Volume Costs

## Graphing Cost-Volume-Profit Relationships

Viewing CVP relationships in a graph gives managers a perspective that can be obtained in no other way. Consider the following information for Curl, Inc.:
300 units Sales \$ 150,000 Less: variable expenses 90,000 Contribution margin \$ 60,000 Less: fixed expenses 80,000 Net income (loss) \$ (20,000) 400 units \$ 200,000 120,000 \$ 80,000 80,000 \$ 500 units \$ 250,000 150,000 \$ 100,000 80,000 \$ 20,000
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Cost-Volume-Profit Graph
450,000 400,000 350,000 300,000

Break-even point

Dollars

## 250,000 200,000 150,000 100,000 50,000

Fixed expenses

100

200

300

400 Units

500

600

700

800

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Profit-Volume Graph

Break even point is the intersection between the total revenues line and the total cost line. The area between the total revenues line and the total cost line at a volume below the breakeven point represent the loss area. The corresponding area above the break even point represents the profit area.

Profit-Volume Graph
100,000 80,000 60,000 40,000

Break-even point

Profit

20,000 0 (20,000) (40,000) (60,000) ` 100 200 300 400 Units 500 600 700

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## EFFECT OF CHANGING SELLING PRICE,VARIABLE COST AND FIXED COST

Changes in the unit selling price : An increase in the unit selling price will raise the contribution margin and decrease in the breakeven volume. Changes in the unit Variable costs : An increase in the unit variable cost leads to a decline in the unit contribution margin and an increase in the breakeven volume. Changes in the total fixed costs : An increase in the total fixed costs will results in an increase in the breakeven volume .

## Target sales for a given target profit

The breakeven formula can be adopted to determine the sales volume necessary to achieve a desire net income.

## Target sales for a given target profit Before tax

Target sales for a given target profit after tax

## Target sales for a given target profit Before tax

Before tax target sales in units, q=F+/P-V =(10000+20000)/(50-30) =1500 units Before tax target sales in dollars, Y=F+/ (1-V/p) =(10000+20000)/1- 30/50 =\$ 75000 where , q=sales volume in units =1000 units P=selling price per unit= \$50 V=variable cost per unit =\$30 F=fixed cost =\$10000 =desired profit before tax =\$20000

## Target sales for a given target profit After tax

After tax target sales in units , q=F+Z/1-t /(P-V)

=10000+(20000/1-.50) /(50-30) =2500 units After tax target sales in dollars , Y=F+Z/1-t /(1-V/P) =10000+(20000 /1-.50) /1- 30/50 =\$125000 where , q=sales volume in units =1000 units P=selling price per unit= \$50 V=variable cost per unit =\$30 F=fixed cost =\$10000 Z=desired profit after tax =\$20000 T=tax rate=50%

## Operating profit at a given sales volume

The operating profit before taxes at the breakeven volume

equals zero .The operating profit for any given sales volume greater than the breakeven volume equals the profit realised by the additional volume beyond the breakeven volume .

## Effects of multiple changes

If the interaction of volume , selling price , variable costs

and fixed costs and taken into account , the breakeven formula can be adapted to reflect the simultaneous changes in all relevant variables . Example: Assume that Smith is considering the impact of different changes on his original estimates . He believe that a decrease of 20% per unit in the selling price may lead to a 30% increase in the sales volume . An improvement of production techniques would lead to a decrease of 90% per unit variable cost and an increase of \$46500 per year in the fixed costs . What level of sales dollar must Smith achieve to attain an after tax netincome of \$18000 if the current tax rate is 50% .

## Effects of multiple changes

where , q=sales volume in units =1000 units P=selling price per unit= \$50 V=variable cost per unit =\$30 F=fixed cost =\$10000 Z=desired profit after tax =\$18000 T=tax rate=50%
q=f+{FZ/(1-t)} 1-(VV / PP)

## OTHER COST-VOLUME-PROFIT RELATIONSHIP

Margin of Safety
The difference between budgeted sales revenue and

break-even sales revenue. The amount by which sales can drop before losses begin to be incurred.

Margin of safety

## LIMITATIONS OF CVP ANALYSIS :

CVP analysis is criticized on the following grounds: 1.Separation of variable & fixed element from mixed cost is the precondition of CVP analysis. But it is really very difficult and costly in consideration of both time &money. 2.This analysis assumes that selling price is constant throughout the entire relevant range but it in reality lit is never constant even within the relevant range. 3.The assumption that there is no inventory or inventory levels do not change is irrelevant. 4.Managers cannot rely absolutely on CVP analysis for any decision rather it can only be used with other techniques to arrive at a decision.

END OF PRESENTATION
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