Cost-Volume-Profit Analysis

CONCEPT OF CVP ANALYSIS

• Cost-Volume-Profit analysis is a systematic method of
examining the relationships between selling price, total
sales revenue, volume of production, expenses and profit.

• It is an important tool that provides management with

useful information for managerial planning and decision
making.
 USES OF CVP ANALYSIS
• Forecast profits
• Forecast sales volume
• Prepare flexible budgets
• Evaluate impact of increased sales volume on profits
• Effect on profit if the FC or VC changes
• Required sales volume to cover additional fixed costs due to higher
investments
• Assessment of contribution on account of changes in sales volume.
• To attain sales level on account of changes in contribution
• Other business operation-related decisions
 TECHNIQUES OF CVP ANALYSIS

• CVP Analysis uses the following techniques or analyses

while answering many questions in the area of
managerial planning and decision making :
1. Contribution Margin Concept
2. Break-even Analysis
3. Profit-volume Analysis
BASIC ASSUMPTIONS OF CVP ANALYSIS
•Changes in production/sales volume are the sole cause for cost
and revenue changes
•Total costs consist of fixed costs and variable costs
•Revenue and costs behave and can be graphed as a linear
function (a straight line)
•Selling price, variable cost per unit and fixed costs are all known
and constant
•In many cases only a single product will be analyzed. If multiple
products are studied, their relative sales proportions are known
constants
•The time value of money (interest) is ignored
 CONTRIBUTION MARGIN CONCEPT
• Contribution margin concept indicates the profit potential of a
business enterprise and also highlights the relationship between
cost, sales and profits.

• Contribution Margin = Sales – Variable Expenses

• Operating Income or Loss = Contribution Margin – Fixed costs

 CONTRIBUTION MARGIN RATIO
(ALSO KNOWN AS C/S RATIO OR P/V RATIO)
• The contribution margin ratio is also known as the “contribution
to sales”(C/S) ratio or Profit-Volume (P/V) Ratio.
• This ratio denotes the percentage of each sales Rupee available
to cover the fixed costs and to provide operating income to a
firm
• The P/V Ratio helps in knowing the effect on income of a firm
due to increase or decrease in sales volume.

• Variable Costing as a percentage to sales = 100% - P/V Ratio

 CONTRIBUTION MARGIN RATIO
• EXAMPLE:

• Sales 10,00,000
• Variable costs 6,00,000
• Fixed Costs 3,00,000

• In this case,
Contribution Margin = Rs.4,00,000
Profit = Rs.1,00,000
Contribution Margin = (Sales – VC )/ Sales = 40%
 UNIT CONTRIBUTION MARGIN
• Unit Contribution Margin is the money available from sale of each unit to cover fixed
costs and provide profits to a firm.
• EXAMPLE :
SELLING PRICE PER UNIT = Rs.100
VARIABLE COST PER UNIT =Rs.60
UNIT CONTRIBUTION MARGIN =Rs.40

• While the P/V Ratio is most useful when the increase or decrease in
sales volume is measured in terms of Rupees, the unit contribution
margin is most useful when increase or decrease in sales volume is
measured in sales units (quantities).
• If a business firm has been able to cover fixed costs, the net income
of the firm will increase by unit contribution margin multiplied by
additional sales units.
 BREAK-EVEN ANALYSIS
• A Break-Even analysis indicates at what level cost and revenue
are in equilibrium.
• Level of sales at which profits are zero and there is no loss.
• It serves as a base indicating how many units of a product must
be sold if a company is to operate without loss.
• At the Break-Even point profit being Zero, Contribution = FC.
• Actual sales > Break-Even volume = Profits
 BREAK-EVEN FORMULA

• BREAK-EVEN SALES (UNITS ) = FIXED COSTS/ CONTRIBUTION

MARGIN PER
UNIT

• BREAK-EVEN SALES (VOLUME) = FIXED COSTS/ (P/V RATIO)

 BREAK-EVEN ANALYSIS
• EXAMPLE :

• Assume that a company manufactures and sells a single product as

follows:
• Selling price per unit = ₹20
• Variable cost per unit =₹10
• Total fixed costs =₹1,00,000

• Break-Even Volume = FC/contribution margin

• The Break-Even sales to cover fixed costs will be 10,000 units.

BREAK-EVEN CHART
 QUESTION:
• Calculate from the following data (i) the value of output at which the
business breaks even; (ii) the percentage of capacity at which it breaks
even :
Particulars Budget based on 100% capacity Shut down Expenditure
Direct Wages 2,09,964
Direct Materials 2,44,552
Works Expenses 88,292 93,528
Selling and Distribution Expenses 21,000 40,188
Administrative Expenses 9,492 20,508
Net Sales 8,40,000
 SOLUTION:
Net Sales 8,40,000
less: Variable Costs:
Direct Wages 2,09,964
Direct Materials 2,44,552
Works Expenses 88,292
Selling and Distribution Expenses 21,000
Administrative Expenses 9,492 5,73,300
Contribution (C) 2,66,700
P/V Ratio (C / Sales ) % 31.75 %

BEP (Amount) = Fixed costs (Shut down Expenditure)/ P/v ratio = 1,54,224/0.3175= Rs. 4,85,744.88

(ii). Break- even sales at 100% capacity = 4,85,744.88/ 8,40,000 = 57.83%

 QUESTION:
• The Soft- Flow Ink Ltd.'s income statement for the preceding year is
presented below. Except as noted, cost/revenue relationship for the
coming year is expected to follow the same pattern as in the preceding
year. Income Statement for the year ending March 31st is as follows:

• Sales (20,000 Bottles @ Rs. 25 each) 5,00,000

Variable Costs 3,00,000
Fixed costs 1,00,000 4,00,000
Pre-Tax Profits 1,00,000
Less: Taxes (0.35) 35,000
Profit After Tax 65,000
 QUESTION: (Contd.)
• 1. What is the break-even point in amount and units?
• 2. Suppose that a plant expansion will add Rs. 50,000 to fixed costs and
increase capacity by 60%. How many bottles would have to be sold after the
addition to break- even?
• 3.The Company’s management feels that it should earn at least Rs. 10,000
(pre-tax per annum) on the new investment. What sales volume is required
to enable the company to maintain existing profits and earn the minimum
required return on new investments?
• 4. Suppose the plant operates at full capacity after the expansion, what
profits after tax will be earned?
 SOLUTION:
• 1. BEP(amount) = 1,00,000/0.40 (2L/5L)= Rs. 2,50,000
• BEP (Units) = 1,00,000/10 = 10,000 Units; CMPU = 25 – 15 VC = Rs. 10
• 2. BEP (Increase in FC) = [1,00,000 + 50,000 (Additional FC)] / 0.40 = Rs.
6,25,000(or 25,000 units)
• 3.
Present Capacity (assumed operating at 100% capacity) (bottles) 20,000
Add: Additional Capacity (60%) 12,000
Total Capacity (bottles ) 32,000

Desired sales volume to earn a pre- tax profit of Rs. 1,10,000 (1,00,000 +
10,000) = (1,50,000 + 1,10,000) / 0.40 = Rs. 6,50,000 (or 26,000 units)
 Statement of Income (32,000 units)

Sales (32,000 bottles @ Rs. 25 ) 8,00,000

Less: Variable Costs (32,000 X 15 or, 0.60 x (3,00,000 + 5,00,000) ) 4,80,000

Contribution 3,20,000

Less: Fixed Costs 1,50,000

Pre- Tax Profits 1,70,000

Less: Income Tax 59,500

Profits after Income Tax 1,10,500

 Question:
• Calculate the break-even sales from the following data for a company
producing three products:
Product Sales Variable Costs
A 10,000 6,000
B 5,000 2,500
C 5,000 2,000
20,000 10,500

Total Fixed Costs Amounts to Rs. 5,700

 Solution:
Determination of Weighted P/V Ratio

Product Sales Variable Costs Contribution

A 10,000 6,000 4,000
B 5,000 2,500 2,500
C 5,000 2,000 3,000
20,000 10,500 9,500
Weighted P/V Ratio = (Total Contribution/ Total Sales) x 100 = (9,500/20,000) x 100 = 47.5%

BEP = FC/ Weighted P/V Ratio = 5,700/ 0.475 = Rs. 12,000

 QUESTION:
• The ABC Ltd. Operates a restaurant with recreational facilities. The
manager of the complex having 100 rooms, has asked your assistance in
planning the coming year’s operations. He is particularly concerned about
the level of profits the firm is likely to earn.
• Your conversation with the manager shows that he expects occupancy to
be 70% during the 200 day session that is open. All rooms would be rented
for Rs. 500 per day for any number of persons. On an average, two
persons occupy a room. This is the past experience, which the manager
believes is an accurate guide for the future. He further informs you that
each person staying in the hotel spends Rs. 125 per day in the shops (also
owned by the company) and Rs. 250 in the restaurant. There are no
charges for the use of recreational facilities.
• Contd……..
 QUESTION: (Contd. )
• Cost Data are:
Particulars Variable cost to Volume Ratio
Shop Restaurant
COGS 50 25
Supplies 5 15
Others 5 10

• For the hotel, The variable per day is Rs. 100 per occupied room, for cleaning, laundry,
and utilities.
• Total Fixed Costs for the complex are Rs. 60,00,000 per year.
• You are required to do the following:
• 1. Prepare an Income Statement for the coming year based on the information given.
• 2. The manager believes that if room rent were reduced to Rs. 400 per day, the
occupancy would increase to 90%. Will you endorse his suggestion of reducing the rent
rates?
 SOLUTION (1/2):
• 1. INCOME STATEMENT

Sales Revenues:
Hotel Rooms (100 x 200 x 0.70 x 500 ) 70,00,000
Shops (100 x 200 x 0.70 x 2 x 125) 35,00,000
restaurants (100 x 200 x 0.70 x 2 x 250) 70,00,000 1,75,00,000
Less: Variable Costs
Hotel rooms (100 x 200 x 0.70 x 100) 14,00,000
Shops (35,00,000 x 0.60 that is, 0.50 + 0.10) 21,00,000
Restaurants (70,00,000 x 0.50 that is 0.25 + 0.15 + 0.10 ) 35,00,000 70,00,000
Contribution 1,05,00,000
Less: FC 60,00,000
Profit 45,00,000
 SOLUTION(2/2):
• 1. INCOME STATEMENT (if room rents are reduced)

Sales Revenues:
Hotel Rooms (100 x 200 x 0.90 x 400 ) 72,00,000
Shops (100 x 200 x 0.90 x 2 x 125) 45,00,000
Restaurants (100 x 200 x 0.90 x 2 x 250) 90,00,000 2,07,00,000
Less: Variable Costs
Hotel rooms (100 x 200 x 0.90 x 100) 18,00,000
Shops (45,00,000 x 0.60 that is, 0.50 + 0.10) 27,00,000
Restaurants (90,00,000 x 0.50 that is 0.25 + 0.15 + 0.10 ) 45,00,000 90,00,000
Contribution 1,17,00,000
Less: FC 60,00,000
Profit 57,00,000
Yes, we endorse the manager’s suggestion
to reduce the room rent as it augments
profits.
 MARGIN OF SAFETY
• This is the difference between sales and break-even
volume.
• If the distance is relatively short, it indicates a small drop
in production or sales will reduce profit considerably.
• If the distance is long it means that the business can still
make profits even after a serious drop in production.

• MARGIN OF SAFETY = PROFIT / (P/V RATIO)

 ANGLE OF INCIDENCE
• This is the angle at
which the sales line
cuts the total cost line.
• Management’s aim
will be to have as large
an angle of incidence
as possible because a
large angle of
incidence shows a high
rate of profit.
 PROFIT-VOLUME (P/V) ANALYSIS

• A P/V Graph is sometimes used in place of or along with a

break-even chart.
• The profits and losses at various sales levels are plotted
and connected by the profit line.
• Limitation: The P/V graph does not clearly show how
costs vary with activity.
P/V GRAPH
 DESIRED PROFIT AND TAX

• DESIRED SALES UNIT = FIXED COST + PROFIT BEFORE TAX / CONTRIBUTION

MARGIN PER UNIT
• DESIRED SALES REVENUE = FIXED COST + PROFIT BEFORE TAX / (P/V RATIO)
• PROFIT BEFORE TAX = PAT/ (1- TAX RATE)
• SALES UNITS FOR DESIRED PROFIT PER UNIT = FIXED COST/ (CONTRIBUTION
MARGIN PER UNIT – DESIRED PROFIT PER
UNIT)
• SALES VOLUME FOR DESIRED PROFIT (AS PERCENTAGE OF SALES) =
FIXED COST / (P/V RATIO- PROFIT MARGIN)
 OPEARTING LEVERAGE
• Operating leverage is a measure of the effect of a
percentage change in sales on profit before taxes.

• Operating Leverage = Contribution margin / Profit

before Tax

• A high operating leverage indicates that a small increase

in sales will give a large percentage increase in net
income.
 INDIFFERENCE POINT
• Helps managers to choose between alternative cost
structures.
• It is the level of volume at which total costs, and hence,
profits, are the same under both cost structures.

• COST INDIFFERENCE POINT = DIFFERENTIAL FIXED COST/

DIFFERENTIAL VARIABLE COST PER UNIT
 INDIFFERENCE POINT
• EXAMPLE:

• Production Method A = Fixed ₹ 40,000; Variable cost per unit ₹ 7

• Production Method B = Fixed ₹ 95,000; Variable cost per unit ₹ 4
• Selling price for both production methods ₹ 10 per unit

• Solution : Total cost for Production A = Total cost for Production B

The indifference point will be 18,333 units.

 Question
• Indian Plastics make plastic buckets. An analysis of their accounting
reveals:
• Variable cost per bucket ₹ 20
• Fixed Cost ₹ 50,000 for the year
• Capacity 2,000 buckets per year
• Selling price per bucket ₹ 70
• Required :
1. Find the break-even point.
2. Find the no. of buckets to be sold to get a profit of ₹ 30,000.
3. If the co. can manufacture 600 buckets more per year with an additional
cost of ₹2,000, what should be the selling price to maintain the profit
per bucket as at (2.) above?
 Solutions:

• 1. BEP = FC/ contribution p.u. = 1,000 buckets

• 2. Sales for desired profit = FC+ desired profit / cont. p.u. = 1,600 buckets
• 3. ₹ 62.39 per bucket
 Question:
• A financial analyst is studying two packaging systems, basic and
deluxe. The basic system has a variable operating cost of ₹ 6 per
unit and annual committed costs of ₹ 6,00,000; in contrast, the
deluxe system has deluxe system has variable cost of ₹ 3 and
committed costs of ₹ 8,00,000. The co. sells its products for ₹ 40
per unit, subject to a 10% sales commission.
1. Which of the two systems will be more profitable for the firm if
the sales are expected to average 1,20,000 units per year?
2. How many units must the company sell to break even if it
selects the deluxe system ?
3. AT what volume level will management be indifferent to the
basic system and the deluxe system?
SOLUTION:
QUESTION:
 SOLUTION:
• 1. BREAK EVEN VOLUME  M1= 5,000; M2=4,000
• 2. AT A PRODUCTION LEVEL OF 7,000 UNITS THE PROFIT MADE
BY M1 AND M2 WOULD BE THE SAME.
• 3. The break even point of M1 IS 5,000 units and compared to
that of 4,000 units in case of M2 and a production level of 7,000
units they earn equal profits. Therefore, M2s profit earning
capacity is more in the region 4,000 to 6,999 units because it
starts earning profits at lower levels as BEP is lower here. Beyond
7,000 units M1 will earn more profits because it has a higher P/V
ratio which enables it to earn more contribution of the
increasing sales.
 Question :
• Style furnishings plan to sell carpets for ₹5,000 each. The company will purchase
the carpets from a local distributor for ₹ 3,500 each, with the privilege of returning
any unsold units for a full refund. It has been offered two payment options:
1. A fixed payment of ₹ 50,000 for the sale period
2. 10% of the total revenues earned during the sale period.

Calculate:
3. Break even point in units for each of the options.
4. At what level of revenues will it earn the same level of operating income under
both the options.
5. At what range each option will be preffered?
6. Calculate the degree of operating leverage at sales of 100 units for the two
options
 Solution :
• 1. BE option 1 : 34 carpets
option 2: 0 carpets
2. 100 carpets
3. Q> 100 = option 1
Q<100 = option 2
4. Degree of Operating leverage :
Option 1= 1.5
Option 2= 1
MULTI-PRODUCT CVP ANALYSIS
 • BE Point =
total fixed cost of all the products in a sales mix/ Composite
PV ratio of all products
• Composite PV Ratio=
Total Contribution of all the products in a sales mix/ Total sale
of all the products
• Contribution Margin=
No. of sales units(contribution) of product A+ No. of sales
units (contribution) of product B + …
Question:
• A multi-product corporation manufacturing products X, Y and Z have the
following costs and output data for the last year:
Question a: Find the overall PV ratio of X,Y and Z assuming the sales mix is in equal
proportion

• Solution:
X’s Contribution = Rs. 20-10 = Rs. 10
Y’s Contribution = Rs. 25- 15 = Rs. 10
Z’s Contribution = Rs. 30 – 18 = Rs. 12
Therefore,
Total Contribution of X, Y and Z = 10+10+12= Rs. 32
Weighted Contribution (equal weights)= Rs. 10.67
Total Selling Price of X,Y and Z = 20+25+30 = Rs. 75
Weighted Selling Price (equal weights)= Rs. 25
Overall PV Ratio (of X, Y and Z) = Rs. 10.67/25 = 42.67%
Question b: Should the company replace Z by S assuming the sales mix is
in equal proportion
• Solution:
a. Scenario 1: without replacement
Overall PV ratio of X,Y and Z is 42.67% and overall sale is Rs. 8,00,000, hence
Overall contribution = 42.67% of Rs. 8,00,000 = Rs. 3,41,360
When FC = Rs. 2,50,000, then
Overall profit (of x, y and z)= Rs. 3,41,360 – 2,50,000 = Rs. 91,360
b. Scenario 2: with replacement
Overall PV ratio of X,Y and S is 46.57% and overall sale is Rs. 8,00,000, hence
Overall contribution = 46.57% of Rs. 8,00,000 = Rs. 3,72,560
When FC = Rs. 2,50,000, then
Overall profit = Rs. 3,72,560 – 2,50,000 = Rs. 1,22,560
As we can see that the net profit is higher in Scenario 2, it is suggested that product Z
should be replaced by S.
Question c: Find the overall PV ratio of X,Y and Z assuming
the sales mix is in the proportion of 50%, 30% and 20%
• Solution:
• X’s Contribution = Rs. 20-10= Rs. 10 [weight in sales mix = 50%]
• Y’s Contribution = Rs.25 -15= Rs. 10 [weight in sales mix = 30%]
Therefore,
Z’s contribution = Rs. 30 – 18 = Rs. 12 [weight in sales mix = 20%]

Total weighted contribution of X, Y and Z = 10x0.5 + 10x0.3 + 12x0.2 = Rs. 10.40

Total weighted selling price of X, Y and Z = 20x0.5 + 25x0.3 + 30x0.2 = Rs. 23.50
Therefore,
Overall PV ratio (X,Y and Z)= Rs. 10.40/ 23.50 =44.26%
 Question:

• Raj Ltd. manufactures three products X, Y and Z. The unit selling price of these
products are Rs. 100, 160 and 75 respectively. The corresponding unit variable
costs are Rs. 50, 80 and 30. The proportions (quantity wise) in which three
products are manufactured and sold are 20%, 30% and 50% respectively. The
total fixed cost is Rs. 14,80,000.
• Calculate the overall BE quantity and product wise breakup of such quantity.
 Solution:
• Let the overall BE quantity be x units,
Therefore, proportions of X, Y and Z to be produced and sold are as follows:
X:2x
Y:3x
Z:5x
Basic Marginal cost equation at BEP
Sales = Variable cost + Fixed Cost
[(0.2x x 100) + (0.3x x 160) + (0.5x x 75)] = [(0.2x X 50) + (0.3x X 80) + (0.5x X 30)] +
14,80,000
56.5x = 14,80,000
X = 26,195  X = 5,239; Y = 7,858; Z= 13,098
Therefore, overall BE quantity is 26,195 units.
THANK YOU!