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Cost Volume Profit AnalysisCost Volume Profit Analysis

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Cost-Volume-Profit Analysis

Examines the behaviour of total revenues, total costs,and operating income as changes occur in the output

level, selling price, variable costs or fixed costs

Assumptions of CVP Analysis1. Revenues change in relation to production and sales

2. Costs can be divided in variable and fixed categories

3. Revenues and costs behave in a linear fashion

4. Costs and prices are known5. If more than one product exists, the sales mix is

constant

6. We can ignore the time value of money

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THE BREAKTHE BREAK--EVEN POINTEVEN POINT

The break-even point is the point in the volume

of activity where the organizations revenues

and expenses are equal.

Sales (Rs.) 2,50,000

Less: Variable expenses 1,50,000

Contribution margin 1,00,000Less: fixed expenses 1,00,000

Net income 0

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EQUATION APPROACHEQUATION APPROACH

Sales revenue Variable expenses Fixed expenses = Profit

UnitUnit

salessales

priceprice

SalesSales

volumevolume

in unitsin units

UnitUnit

variablevariable

expenseexpense

SalesSales

volumevolume

in unitsin units

(Rs. 500 X)X) (Rs.300 X)X) Rs.80,000 = Rs.0

(Rs.200X)X) Rs.80,000 = Rs.0

X = 400 surf boardsX = 400 surf boards

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CONTRIBUTIONCONTRIBUTION--MARGIN APPROACHMARGIN APPROACH

For each additional surf board sold, Curl generatesRs.200 in contribution margin.

Consider the following information developedby the accountant at Curl, Inc.:

Total Per Unit Percent

Sales (500 surf boards) Rs. 250,000 Rs. 500 100%

Less: variable expenses 150,000 300 60%

Contribution margin Rs. 100,000 Rs. 200 40%

Less: fixed expenses 80,000

Net income Rs. 20,000

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Fixed expensesFixed expenses

Unit contribution marginUnit contribution margin==

BreakBreak--even pointeven point

(in units)(in units)


Sales (500 surf boards) Rs. 250,000 Rs. 500 100%

Less: variable expenses 150,000 300 60%



Net income Rs. 20,000

Rs.Rs.80,00080,000

Rs.Rs.200200 == 400 surf boards400 surf boards

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Sales (400 surf boards) Rs. 2,00,000 Rs. 500 100%

Less: variable expenses 1,20,000 300 60%



Net income Rs. 0


Here is the proof!

400400 Rs.500 = Rs.200,000Rs.500 = Rs.200,000 400400 Rs.300 = Rs.120,00Rs.300 = Rs.120,00

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CONTRIBUTION MARGIN RATIOCONTRIBUTION MARGIN RATIO

Calculate the break-even point in Rs. sales rather than

units by using the contribution margin ratio.

Contribution margin

Sales= CM Ratio

Fixed expenseFixed expense

CM RatioCM Ratio

BreakBreak--even pointeven point

(in sales dollars)(in sales dollars)==

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CONTRIBUTION MARGIN RATIOCONTRIBUTION MARGIN RATIO

Rs.80,000Rs.80,000

40%40%

Rs.200,000 salesRs.200,000 sales==


Sales (400 surf boards) Rs. 2,00,000 Rs. 500 100%

Less: variable expenses 1,20,000 300 60%



Net income Rs. 0

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GRAPHING COSTGRAPHING COST--VOLUMEVOLUME--PROFITPROFITRELATIONSHIPSRELATIONSHIPS

Viewing CVP relationships in a graph givesmanagers a perspective that can be obtained in noother way.

Consider the following information for Curl, Inc.:

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COSTCOST--VOLUMEVOLUME--PROFIT GRAPHPROFIT GRAPH

Do

ars

600 700 800Un ts

200 300 400 500

450,000

100

200,000

150,000

100,000

50,000

400,000

350,000

300,000

250,000

Fixed expenses

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Do

ars

600 700 800Un ts

200 300 400 500

450,000

100

200,000

150,000

100,000

50,000

400,000

350,000

300,000

250,000

Fixed expenses

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Do

ars

600 700 800Un ts

200 300 400 500

450,000

100

200,000

150,000

100,000

50,000

400,000

350,000

300,000

250,000

Fixed expenses

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Do

ars

600 700 800Un ts

200 300 400 500

450,000

100

200,000

150,000

100,000

50,000

400,000

350,000

300,000

250,000

Fixed expenses

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Do

ars

600 700 800Un ts

200 300 400 500

450,000

100

200,000

150,000

100,000

50,000

400,000

350,000

300,000

250,000

Fixed expenses

Break-even

point

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PROFITPROFIT--VOLUME GRAPHVOLUME GRAPH

Some managers like the profit-volumegraph because it focuses on profits and volume.

100 200 300 400 500 600 700

Units

P

it

0

100,000

(20,000)

(40,000)

(60,000)

80,000

60,000

40,000

20,000

Break-even

point

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TARGETNET PROFITTARGETNET PROFIT

We can determine the number of surfboards that

Curl must sell to earn a profit of Rs.100,000 using

the contribution margin approach.

We can determine the number of surfboards that

Curl must sell to earn a profit of Rs.100,000 using

the contribution margin approach.

Fixed expenses + Target profit

Unit contribution margin=

Units sold to earn

the target profit

Rs.80,000 + Rs.100,000

Rs.200

Rs.80,000 + Rs.100,000

Rs.200= 900 surf boards= 900 surf boards

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EQUATION APPROACHEQUATION APPROACH

Sales revenue Variable expenses Fixed expenses = Profit

(Rs.500 X)X) (Rs.300 X)X) Rs.80,000 = Rs.100,0Rs.100,0Rs.80,000 = Rs.100,0Rs.100,0

(Rs.200X)X)= Rs.180,000= Rs.180,000

X = 900 surf boardsX = 900 surf boards

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EFFECT OF INCOMETAXESEFFECT OF INCOMETAXES

Target after-tax net income1 - t

= Before-tax

net income

Income taxes affect a companys CVP

relationships. To earn a particular

after-tax net income, a greater before-

tax income will be required.

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APPLYING CVP ANALYSISAPPLYING 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.

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.

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SAFETY MARGINSAFETY MARGIN

Curl, Inc. has a break-even point of Rs.200,000. If

actual sales are Rs.250,000, the safety margin is

Rs.50,000 or 100 surf boards.

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CHANGES IN FIXED COSTSCHANGES IN FIXED COSTS

Curl is currently selling 500 surfboards per year.

The owner believes that an increase of

Rs.10,000 in the annual advertising budget,

would increase sales to 540 units.

Should the company increase the advertising

budget?

Curl is currently selling 500 surfboards per year.

The owner believes that an increase of

Rs.10,000 in the annual advertising budget,

would increase sales to 540 units.

Should the company increase the advertising

budget?

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Rs.80,000 + Rs.10,000 advertising = Rs.90,0

540 units Rs.500 per unit = Rs.270,000

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Sales will increase by

Rs.20,000, but net income

decreaseddecreased by Rs.2,000..

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CHANGES INUNITCHANGES INUNITCONTRIBUTION MARGINCONTRIBUTION MARGIN

Because of increases in cost of raw materials, Curls

variable cost per unit has increased from Rs.300 toRs.310 per surfboard. With no change in selling

price per unit, what will be the new break-even point?

Because of increases in cost of raw materials, Curls

variable cost per unit has increased from Rs.300 toRs.310 per surfboard. With no change in selling

price per unit, what will be the new break-even point?

(Rs.500 X)X)(Rs.500 X)X) (Rs.310 X)X)(Rs.310 X)X) Rs.80,000 = Rs.0Rs.80,000 = Rs.0

X = 422 unitsX = 422 units (rounded)(rounded)

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CHANGES INUNITCHANGES INUNITCONTRIBUTION MARGINCONTRIBUTION MARGIN

Suppose Curl, Inc. increases the price of each

surfboard to Rs.550. With no change in

variable cost per unit, what will be the new

break-even point?

Suppose Curl, Inc. increases the price of each

surfboard to Rs.550. With no change in

variable cost per unit, what will be the new

break-even point?

(Rs.550 X)X)(Rs.550 X)X) (Rs.300 X)X)(Rs.300 X)X) Rs.80,000 = Rs.0Rs.80,000 = Rs.0

X = 320 unitsX = 320 units

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PREDICTING PROFIT GIVENPREDICTING PROFIT GIVENEXPECTED VOLUMEEXPECTED VOLUME

Fixed expenses

Unit contribution margin

Target net profitFind: {reqd sales volume}Given:Given:

Fixed expenses

Unit contribution margin

Expected sales volumeF

ind: {expected profit}Given:Given:

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PREDICTING PROFIT GIVENPREDICTING PROFIT GIVENEXPECTED VOLUMEEXPECTED VOLUME

In the coming year, Curls owner expects to sell 525

surfboards. The unit contribution margin is

expected to be Rs.190, and fixed costs are

expected to increase to Rs.90,000.

In the coming year, Curls owner expects to sell 525

surfboards. The unit contribution margin is

expected to be Rs.190, and fixed costs are

expected to increase to Rs.90,000.

(Rs.190 525)525)(Rs.190 525)525) Rs.90,000 = XRs.90,000 = X

X = Rs.9,750 profit

X = Rs.99,750 Rs.90,000

Total contribution - Fixed cost = Profit

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CVP ANALYSIS WITH MULTIPLECVP ANALYSIS WITH MULTIPLEPRODUCTSPRODUCTS

For a company with more than one product, sales

mix is the relative combination in which a

companys products are sold.

Different products have different selling prices, cost

structures, and contribution margins.

Lets assume Curl sells surfboards and sailboards and see how we deal with break-even

analysis.

For a company with more than one product, sales

mix is the relative combination in which a

companys products are sold.

Different products have different selling prices, cost

structures, and contribution margins.

Lets assume Curl sells surfboards and sailboards and see how we deal with break-even

analysis.

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Curl provides us with the following information:

Description SellingPrice

Unit

VariableCost

Unit

ContributionMargin

Number

ofBoards

Surfboards 500$ 300$ 200$ 500

Sailboards 1,000 450 550 300

Total sold 800

Description

Number

of Boards

% of

Total

Surfboards 500 62.5% (500 800)

Sailboards 300 37.5% (300 800)

Total sold 800 100.0%

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Weighted-average unit contribution margin

Description

Contribution

Margin % of Total

Weighted

ContributionSurfboards 200$ 62.5% 125.00$

Sailboards 550 37.5% 206.25

Weighted-average contribution margin 331.25$

Rs.200 62.5%

Rs.550 37.5%

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Break-even point

Break-even

point =

Fixed expenses

Weighted-average unit contribution margin

Break-even

point=

Rs.170,000

Rs.331.25

Break-even

point= 514 combined unit sales514 combined unit sales

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Break-even pointBreak-even

point

= 514 combined unit sales

Description

Breakeven

Sales

% of

Total

Individual

Sales

Surfboards 514 62.5% 321

Sailboards 514 37.5% 193

Total units 514

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ASSUMPTIONS UNDERLYINGASSUMPTIONS UNDERLYINGCVP ANALYSISCVP ANALYSIS

1. Selling price is constant throughout

the entire relevant range.

2. Costs are linear over the relevant

range.

3. In multi-product companies, the sales

mix is constant.

4. In manufacturing firms, inventories donot change (units produced = units

sold).

1. Selling price is constant throughout

the entire relevant range.

2. Costs are linear over the relevant

range.

3. In multi-product companies, the sales

mix is constant.

4. In manufacturing firms, inventories donot change (units produced = units

sold).

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CVP RELATIONSHIPS ANDCVP RELATIONSHIPS ANDTHE INCOME STATEMENTTHE INCOME STATEMENT

A. Trad o al orma

Sale $

Le :

ro marg $

Le : Opera gexpe e :

Sell gexpe e $Adm ra veexpe e

Ne come $

ACCUTIME COMPANY

I come S a eme

For heYearE dedDecember x

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COST STRUCTURE AND OPERATINGCOST STRUCTURE AND OPERATINGLEVERAGELEVERAGE

The cost structure of an organization is therelative proportion of its fixed and variablecosts.

Operating leverage is . . .

the extent to which an organization uses fixedcosts in its cost structure.

greatest in companies that have a highproportion of fixed costs in relation tovariable costs.

The cost structure of an organization is therelative proportion of its fixed and variablecosts.

Operating leverage is . . .

the extent to which an organization uses fixedcosts in its cost structure.

greatest in companies that have a highproportion of fixed costs in relation tovariable costs.

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MEASURING OPERATING LEVERAGEMEASURING OPERATING LEVERAGE

Contribution margin

Net income

Operating leverage

factor=

Rs.100,000Rs.100,000

Rs.20,000Rs.20,000

= 5= 5

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A measure of how a percentage change in sales

will affect profits. If Curl increases its sales by

10%, what will be the percentage increase in

net income?

A measure of how a percentage change in sales

will affect profits. If Curl increases its sales by

10%, what will be the percentage increase in

net income?

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A firm with proportionately high fixed costs has

relatively high operating leverage On the other hand, a

firm with high operating leverage has a relatively high

break-even point.

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END OF UNIT 1END OF UNIT 1

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