Cost Volume Profit Analysis

Cost-Volume-Profit Analysis

The main objective of an organization is to earn profit and profit depends on 3 (three) basic factors. These are:

Cost of productionSelling prices Volume of sales


• These three factors are inter dependent because selling price depends to a certain extent on cost if a desired profit is to be obtained and volume of depends upon volume of production, which in turn is related to costs. For budgeting and profit planning the management should have an understanding of the inter relationship between these factors.


Cost –Volume-Profit (CVP) analysis helps managers understand this relationship by focusing on interactions among five elements. These are:

Selling price Volume of sales or level of activity

Product mix of salesVariable costs per unitTotal fixed costs

Break-even Analysis

• The study of cost-volume-profit analysis is often referred to as break-even analysis but there are some fundamental differences between them. The term break even analysis is used in narrow as well as broad sense. In its narrow sense, break-even analysis is concerned with finding out the level of activity or volume of sales where total revenue is equal to total costs i.e. the break-even point. In a broad sense, it refers to the analysis of relationship between cost, volume and profit at different levels of sales or production.

Underlying Assumptions of Break-even Analysis

The break-even analysis is based on the following assumptions:– All costs are divided into fixed & variable.– Total fixed costs remain constant.– Variable cost per unit remains constant.– Selling prices are to be unchanged.– All units produced are sold.– There is only one product or in case of multiple.

products the sales mix will remain constant.– Efficiency and productivity do not change.

Approaches/Techniques for Break even Point Calculation

Break even point is a point or level of sales at which revenues are equal to expenses.

That is at this point there is no profit or loss. Break even point can be computed using either

Contribution Margin (CM) is the excess of selling price over the variable cost per unit.

Contribution Margin Technique/Approach

Equation Technique/Approachor

Contribution Margin Technique

The break-even point can be defined either as:– The point where total sales revenue equals total

expenses (variable and fixed).– The point where total contribution margin equals

total fixed expenses.

Contribution Margin (CM) is the excess of selling price over the variable expenses


Total Per UnitSales (500 speakers) Tk. 250,000 Tk. 500 Less Variable expenses 150,000 300Contribution margin 100,000 Tk.200 Less Fixed expenses 80,000 Net operating income Tk. 20,000 If the contribution margin is not sufficient to cover the fixed costs, then a loss occurs for the period.

Example: Suppose a company sells 500 speakers @ Tk. 500 each per month. The variable cost per unit is Tk. 300 and fixed cost are Tk. 80,000.


To illustrate with an extreme example, assume that by the middle of a particular month the company has been able to sell only 1 speaker. If the company does not sell any more speaker during the month, the company’s income statement will appear as you see in the next slide.

Contribution Margin TechniqueTotal Per Unit

Sales (1 speaker) Tk. 500 Tk. 500 Less Variable expenses 300 300Contribution margin 200 Tk.200 Less Fixed expenses 80,000 Net loss Tk. 79,800

Each speaker sold yields Tk. 200 in contribution margin. So, to reach the break even point i,e; to cover the fixed expenses of Tk. 80,000, the company will have to sell 400 speakers in a month.


Total Per UnitSales (400 speakers) Tk. 200,000 Tk. 500 Less Variable expenses 120,000 300Contribution margin 80,000 Tk.200 Less Fixed expenses 80,000 Net operating income Tk. 0

If the company sells 400 speakers in a month, it will be operating at the break-even point.

Equation Technique[

Sales revenue – Variable expenses – Fixed expenses = Profit

Unitsalesprice

Salesvolumein units

×Unit

variableexpense

Salesvolumein units

×

(Tk. 500 × N) –

The equation technique is the most general form of analysis where the income statement can be expressed in equation form or as a mathematical model as you see in the television screen.

(Tk. 300 × N) Tk. 80,000 – = Tk. 0

Equation TechniqueThe break-even point in unit sales, N, can be Computed

as follows:

Sales revenue = Variable expenses – Fixed expenses + Profit»Tk. 500 N= Tk. 300 N + Tk. 80,000 + Tk. 0»Tk. 500 N- Tk. 300 N = Tk. 80,000 + Tk. 0»Tk. 200 N= Tk. 80,000 »N= 80,000/200 ..N= 400 speakers

Where N= No. of speakers sold Tk. 500= Unit sales price Tk. 3000= Unit variable expense

Therefore, BEP (units)= Fixed ExpenseUnit Contribution Margin

Equation TechniqueThe break-even point in sales taka, S, can be

Computed as follows:

Sales revenue = Variable expenses – Fixed expenses + Profit»Tk. S= Tk. 0.60 S + Tk. 80,000 + Tk. 0»Tk. S- 0.60S = Tk. 80,000 + Tk. 0»Tk. 0.40S= Tk. 80,000 »S= 80,000/0.40 S= Tk. 200,000

Where S= Sales Tk. Tk. .60= VE as a % of sales

Therefore, BEP (Tk.)= Fixed Expense

Contribution Margin Ratio

Contribution Margin Ratio

Contribution Margin Ratio= Contribution Margin

Sales

For the company, the contribution margin ratio is:

Tk.200 Tk. 500 = 40%

Profit= CM Ratio × Sales - Fixed Expenses

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

- 100 200 300 400 500 600 700 800

Cost-Volume-Profit Graph

Fixed expenses

Volume in speakers sold (units)

Sale

s in

Tak

a

Total expenses

Total salesBreak-evenpoint

Profit area

Loss area Variable expenses

Target Net Profit We can determine the number of speakers

that the company must sell to earn a profit of Tk. 100,000 using the contribution margin approach.

Fixed expenses + Target profit Unit contribution margin = Units sold to earn

the target profit

Tk.80,000+Tk.100,000 Tk. 200

= 900 speakers

Applying CVP Analysis

Safety Margin• The difference between budgeted sales

revenue and break-even sales revenue.• The amount by which sales can drop

before losses begin to be incurred.

M/S=Tk. 250,000-Tk. 200,000=Tk. 50,000

Documents

Cost Volume Profit Analysis