Cost Volume Profit Analysis – CVP

Break-even analysis
adapted, Claudia Wittmann
Learning Objectives
By the end of this lecture, students should be able to:
Discuss CVP (cost volume profit analysis) – particularly, cost behaviour and explain what is
meant by the terms “fixed” and “variable” in relation to costs
•Explain what is meant by break-even analysis, calculate break-even points, present information
in a form that aids decision-making (including graphically)
•Describe and discuss the relationships between profit, cost and volume and the concepts of
contribution, and margin of safety.
•State the assumptions on which the accountants’ model of breakeven rests, compare this
model with the economists’ model and outline the limitations of breakeven analysis
•Discuss qualitative factors that might be relevant to decisions and make recommendations to
management on the basis of your analyses.
 The behaviour of costs

Costs may be
classified as:

Remain constant (fixed)

when changes occur to the
Fixed volume of activity

Vary according to the volume

Variable of activity
 Graph of fixed cost against
the volume of activity

Cost
(£)

0
Volume of activity (units of output)
 Graph of rent cost against
the volume of activity – step(ped) fixed cost

Rent
cost
(£)

0 Volume of activity
 Graph of variable cost against
the volume of activity

Cost
(£)

0
Volume of activity
Application 1
 Graph of electricity cost against
the volume of activity – semi fixed/variable costs

Electricity The slope of this line

cost gives the variable cost
per unit of activity
(£)

Fixed
cost
element

0 Volume of activity
Application 1, cont -- fixed cost in total vs per unit
Application 2
Application 3
Application 3, cont -- variable cost in total, per unit
Application 4
Application 4 -- solution
Graph of total cost against
the volume of activity
 Break-even chart

Total sales
Revenue/ revenue
Cost (£)
Break-even
point fi t
P ro
Total cost

Variable
s cost
Lo s
F

Fixed cost

0
Volume of activity (units of output)

Copyright © 2020, 2016, 2014 Pearson Education, Inc. All Rights Reserved
What is Break-Even Point and why is it
important?
BEP is the point at which a business makes neither profit nor loss.
It helps in making short-term decisions such as:

How many units do we need to sell to make a certain profit?

How many units do we need to sell to cover our costs?
By how much will profit fall if price is lowered by €1?
What will happen to our profits if we rent an extra factory but find that we can
operate at only half capacity?
How safe is the business in moving away from loss-making?
Establishing the break-even point (BEP)
Key terminology
•Sales revenue – variable costs = Contribution
•Think of this as standing for “contribution … towards fixed costs and profit”

Contribution can be either:

•Total (total sales revenue – total variable costs), or
•Per unit (selling price – variable cost per unit)
How to calculate contribution
An Illustration
Profit Statement for the production and sale Contribution per unit:
of 10,000 units
1. Either: €20.00 - €8.00 = €12.00
2. Or: €120,000/10,000units =€12.00
€
Sales (10,000units X €20) 200,000
Contribution Margin (c/s ratio):
Variable Costs (10,000 X €8) 80,000
1. Either: €12.00/€20.00 =60% or
Contribution (10,000 X €12) 120,000 0.6
2. Or: €120,000/€200,000 =60% or 0.6
Establishing the break-even point (BEP)
Substituting the notion of ‘contribution’ into our formula,
at the breakeven point:
•Total contribution = Total fixed costs
•Or, playing around with individual units of output:

Contribution per unit x number of units = total fixed costs

•Therefore:
•BEP (number of units) = Total Fixed Costs / Contribution per unit
•BEP (Revenue) = BEP (units) x Sales Price
 € Break-Even Analysis Chart
Budgeted
ue profits
ven
e
le sr
Sa
Break even point

€B Budgeted
variable costs

l co sts
Tota
Fixed costs
€F

Margin Budgeted
of safety fixed costs

0 Units
B

Monday, April 22, 2024

Illustration Question 1
Miss Moneypenny wants to open a pizza restaurant named “007”
•She intends to sell an “all-inclusive” meal at €25 per meal
•She expects 300 customers each week, every week of the year
•Her variable costs are €15 for each meal, and
•Her fixed costs are €75,000 per year
(mainly rent and the manager’s salary)

Required:
1. Determine the annual break-even point in number of meals, and in sales revenue
2. Calculate the annual Margin of Safety
break-even point in number of meals,
and in sales revenue (1)
BEP (units) = Total Fixed Costs /contribution per unit
BEP (€) = Total Fixed Costs/contribution margin ratio*

BEP (units) = €75,000 /(€25 - €15) = 7,500 meals

BEP (€) = €75,000/0.40 = €187,500

*contribution margin ratio = contribution / sales

*also known as “c/s ratio”
Proof of break-even point
€

Sales revenue (7,500 x €25) 187,500

Less: variable costs (7,500 x €15) 112,500

Contribution (7,500 x €10) 75,000
Less fixed costs 75,000
Profit / Loss 0
Margin of Safety (2)
Margin of Safety is the maximum tolerable unfavourable change in sales units or
revenue. It is the difference between “where we are, and the break-even point”.

i.e. MOS (%) = [current sales (units) – BEP (units)] / current sales (units)
or MOS (%) = [current sales (€) – BEP (€)] / current sales (€)

Either (15,600 – 7,500)/15,600 = 51.92%

Or (€390,000 - €187,500) / €390,000 = 51.92%

Formula to be used depends on the data provided.

Illustration Question 2
1. If Miss Moneypenny wants to make an annual profit of
€95,000, how many meals does she need to sell each year?

2. What if she wants to make an after-tax profit of €60,000?

How many meals does she need to sell each year?
Assume a corporate tax rate of 25%
Answer to illustration 2
TO ACHIEVE €95,000 PROFIT TO ACHIEVE €60,000 AFTER-TAX PROFIT

Formula = Formula =
[FC + TP] / contribution per unit [FC + (TP/1-tax rate)]/ contribution per unit
= [€75,000 + €95,000] / €10 = [€75,000 + (€60,000/0.75)] / €10
= 17,000 meals = 15,500 meals
Proof of Answer to illustration 2
SELL 17,000 MEALS TO ACHIEVE SELL 15,500 MEALS TO ACHIEVE
€95,000 PROFIT €60,000 AFTER-TAX PROFIT
€ €
Sales revenue (17,000 x €25) 425,000 Sales revenue (15,500 x €25) 387,500
Less: variable costs(17,000 x €15) 255,000 Less: variable costs(15,500 x €15) 232,500
Contribution (17,000 x €10) 170,000 Contribution (15,500 x €10) 155,000
Less fixed costs 75,000 Less fixed costs 75,000

Profit / Loss 95,000 Profit / Loss before tax 80,000

Less tax at 25% 20,000
Profit after tax 60,000
Application
 Application
€/unit €/unit
You are required to calculate:
Selling price 120
Direct material 22 1. The breakeven point, in sales units per month;
Direct labour 36 2. The margin of safety for next month;
Variable overhead 14
3. The budgeted profit for next month;
Fixed overhead 12
___ 4. The sales required to achieve a profit of €96,000

in a month.
84___
Profit per unit 36
===
The fixed overhead rate is based on the normal capacity of 2,000
units per month. Assume that the same amount is spent each
month on fixed overheads. Budgeted sales for next month are
2,200 units.
Group Exercise Answers
1. The breakeven point, in sales units per month: 500 units
2. The margin of safety for next month: 1700 units or 77% of budgeted sales
3. The budgeted profit for next month: €81,600
4. The sales required to achieve a profit of
€96,000 in a month: 2,500 units
 P/V (Profit/volume) Charts:
provide a simple illustration of the relationship of costs and profits to sales,
and of the margin of safety.
€

Budgeted
profits

Breakeven point
Sales volume or
€x Sales revenue

Budgeted
Fixed contribution
costs

Loss

Units

Monday, April 22, 2024

 Economist Model/View of Break-Even Analysis

Total cost
€
BEP
(2)

Total revenue

Profit zone

BEP
(1)

Loss

output

Monday, April 22, 2024

Assumptions/Limitations of Break-Even
Analysis Model
The variable costs behave in a linear fashion

The fixed cost will remain unchanged within the relevant range

The selling price is fixed per unit.

There are no opening or closing stocks

There are no changes in the time value of money

Certainty in the estimates of fixed and variable costs

Interactive Question 1
Which of the following statements is NOT correct?
i. At Break-even point, Fixed Cost is equal to Contribution
ii. At zero production level, the maximum loss equals to Fixed Cost
iii. Margin of Safety is the difference between the current activity level and the
Break- even point.
iv. At break-even point, Total Revenue equals Variable costs plus Fixed costs.

A. Statements (i) only

B. Statements (ii) and (iv)
C. Statements (iv) only
D. None of the above
Interactive Question 2
What is the margin of safety in
percentage, assuming the
current production level is
1,800 units?
A. 68.00%
B. 28.00%
C. 21.88%
400 1,250 1,600 1,800
D. 30.56%
A company that sell its products at What is the budgeted break-
€60 per unit has the following even sales unit?
budgeted information for the month
of April 2015:

Budgeted variable costs

A. 7,500 units 1
€450,000
B. 6,000 units
Budgeted contribution C. 10,000 units
€150,000 D. 5,000 units
Budgeted profit € 60,000
Interactive Question 4
B Ltd manufactures a single product B Ltd’s margin of safety,
which it sells for €9 per unit. in units, was:
Fixed costs are €54,000 per month A. 2,000
and the product has a variable cost of B. 14,000
€6 per unit.
C. 18,000
In a period when actual sales were
€180,000, D. 20,000
Interactive Question 5A
The following facts were given in respect of a company. Use these facts to answer question 5A and 5B
2014 2015
Units Produced 5,250 7,750
TOTAL SALES €189,000 €279,000
PROFITS / (LOSS) € (7,000) € 5,250

The estimated business Revenue, Total Cost and Profits in 2016, assuming that 8,000 units were
produced and sold would be:
Revenue Total Cost Profit
A. €288,000 €232,250 €55,750
B. €288,000 €281,525 €6,475
C. €288,000 €272,500 €15,500
D. €288,000 €275,750 €12,250
Interactive Question 5B
The following facts were given in respect of a company. Use these facts to answer question 5 (a) and 5(B)
2014 2015
Units Produced 5,250 7,750
TOTAL SALES €189,000 €279,000
PROFITS / (LOSS) € (7,000) € 5,250
Assuming 8,000 activity level, the Margin of Safety and the Break-Even point in units are:
Margin of Safety Break-Even Point
A. 1,321 units 6,679 units
B. 1,950 units 6,050 units
C. 6,250 units 1,750 units
D. 2,150 units 5,850 units
Interactive Question 6A
QUESTION 6A – 6B
Hot Toddy Limited sells one product for which data is given below:
Selling price €20 per unit
Variable cost €12 per unit
Fixed cost per period €40,000
If Hot Toddy Co wishes to earn a minimum profit of €10,000 for one period, the number of units that must
be sold is:
A. 10,000
B. 2,500
C. 4,167
D. 6,250
Interactive Question 6B
QUESTION 6A – 6B
Hot Toddy Limited sells one product for which data is given below:
Selling price €20 per unit
Variable cost €12 per unit
Fixed cost per period €40,000
Calculate Hot Toddy Co’s margin of safety for the budget period if fixed costs prove to be 10% higher than
budgeted, and budgeted sales are 10,000 units, is:
A. 45%
B. 41%
C. 55%
D. 49%
Interactive Question 7
Which line represents the
total contribution at the
corresponding level of
€
M output?
A. Line J
J
output
L
B. Line K
K
C. Line L
D. Line M
Interactive Question 8
Which line represents the
total contribution at the level
of activity?
€
A. Line P
S
B. Line Q
output

P Q
R
C. Line R
D. Line S
Interactive Question 9
An organisation manufactures and sells a single product which has a variable
cost of €24 per unit and a contribution to sales ratio of 40%. Total monthly
fixed costs are €720,000.
What is the monthly breakeven point (in units)?
A 18,000
B 20,000
C 30,000
D 45,000
Interactive Question 10
An organisation manufactures a single product. The total cost of making 4,000 units is €20,000
and the total cost of making 20,000 units is €40,000. Within this range of activity the total fixed
costs remain unchanged.
What is the variable cost per unit of the product?
A €0·80
B €1·20
C €1·25
D €2·00
ANSWERS TO INTERACTIVE
QUESTIONS
1. D 6A. D
2. D 6B. A
3. B 7. C
4. A 8. C
5A. B 9. D
5B. A 10. C
Summary – CVP Analysis
Summary –Use of CVP
Limitations of CVP
Limitations of CVP
Variable cost per unit can be distorted by:
• Overtime rates paid to direct labor
• Bulk discounts received on purchases of raw materials
• For multi-product firms,
changes in the sales mix will change break-even point,
C/S ratio
• CVP assumes production equals sales
– ignores inventory movements
Thank you