2.
SYNOPSIS
DEFINITION
PROFIT ANALYSIS
PROFIT VOLUME GRAPH
EFFECTS
UTILITY
LIMITATIONS
BREAK EVEN ANALYSIS CHART AND
LIMITATIONS
3.
CVP ANALYSIS
• The analytical technique that is used to
study the behavior of profit in response to
change in volume, cost and prices is
called CVP analysis.
4.
• Cost-Volume-Profit Analysis (CVP), It is a
simplified model, useful for short-run decisions.
• A critical part of CVP analysis is the point where
total revenues equal total costs (both fixed and
variable costs).
• Cost-volume-profit analysis employs the same
basic assumptions as in breakeven analysis
5.
Assumptions underlying CVP
analysis
• Cost segregation : the total cost can be
separated in to fixed and variable components.
• Constant unit variable cost : variable cost per
unit is constant and total variable cost change in
direct proportion to sales volume.
• Constant fixed cost : total fixed cost remains
unchanged with changes in sales volume.
6.
• Constant selling price : the selling price per unit
remains constant that it does not change with
volume or because of other factors.
• Constant sales mix : the firm manufactures only
one product or if there are multiple products, the
sales mix does not change.
• Synchronized production and sales : inventory
level remains the same
7.
The components of Cost-Volume-Profit
Analysis are:
• The volume or level of activity is the activity that causes changes in
the behaviour of cost. The changes should be correlated with
changes in cost
unit selling price is linked directly to profit and includes all costs and expenses
pertaining to production and sale of the product
Variable costs are corporate expenses that vary in direct proportion to the quantity
of output. Unlike fixed costs, which remain constant regardless of output, variable costs
are a direct function of production volume, rising whenever production expands
and falling whenever it contracts. Examples of common variable costs include
raw materials, packaging, and labour directly involved in a company's manufacturing
process.
8.
• A cost that remains unchanged even with
variations in output is know as fixed cost.Yotal
fixed cost remains constant.
• sales mix
• Proportion of total sales which each product or
product line generates, and which needs to be
appropriately balanced to achieve the maximum
amount of gross profit.
9.
Basic graph
• The assumptions of the CVP model yield the following linear equations for total costs
and total revenue (sales):
–
–
• These are linear because of the assumptions of constant costs and prices, and there
is no distinction between Units Produced and Units Sold, as these are assumed to be
equal. Note that when such a chart is drawn, the linear CVP model is assumed, often
implicitly.
• In symbols:
–
–
• where
• TC = Total Costs
• TFC = Total Fixed Costs
• V = Unit Variable Cost (Variable Cost per Unit)
• X = Number of Units
• TR = S = Total Revenue = Sales
• P = (Unit) Sales Price
• Profit is computed as TR-TC; it is a profit if positive, a loss if negative.
11.
• total cost = fixed costs + unit variable cost
* amount
describes the total economic cost of production and is made up of variable costs,
which vary according to the quantity of a good produced and include inputs such
as labor and raw materials, plus fixed costs, which are independent of the quantity
of a good produced and include inputs (capital) that cannot be varied in the
short term, such as buildings and machinery
12.
PROFIT ANALYSIS
• Profit is affected by change in
volume,cost,and prices. This is used to
reflect the effect of change in one or more
factors on profit.
• CVP analysis is used to reflect the effect
of changes in one or more factors on
profit.
13.
PROFIT VOLUME GRAPH
• The graph has 2 parts, separated by sales line.
• The upper part of the graph indicates profit.
• Fixed cost are marked on the lower part.
• The amount of fixed cost unrecovered is loss
• incurred
• Profit line is drawn by joining fixed cost point and
• sales line at the breakeven point.
14.
EFFECT OF CHANGE ON PROFITS
• Profits may be effected by changes-
increase or decrease in the following
factors:
• Selling price
• Volume
• Variable cost
• Fixed cost
• A combination of all or any of the above 4
factors
15.
The following data is analyzed to show effect of change in
various factors on profit
Budgeted sales
volume(100000@Rs 20)
20,00,000
Less budgeted variable
cost (100000@Rs 10)
10,00,000
Budgeted contribution 10,00,000
Less budgeted fixed
cost
4,00,000
Budgeted net profit 6,00,000
bep 8,00,000
p/v ratio 50%
16.
• The selling price may change because of
economic factor or management itself may
initiate changes due to increase or
decrease in cost or competition or for
some other reason. Most cost are
controllable and are affected by volume
changes. The ultimate impact of changing
factors is on the firms profit.
17.
EFFECT OF CHANGE IN PRICE
Change in
price
Decrease
(20%)
budget Increase(2
0%)
Units 100000 100000 100000
Selling
price
16 20 24
Variable
cost
10 10 10
Contributio
n
6 10 14
Fixed cost 1600000 2000000 2400000
18.
Variable
cost
1000000 1000000 1000000
Contributio
n
600000 1000000 1400000
Fixed cost 400000 400000 400000
Net profit 200000 600000 1000000
Percentage
change in
profit
-66.7% - +66.7%
p/v ratio 37.5% 50% 58.3%
19.
• An increase in selling price will increase
the p/v ratio and as a result it reduces
break even point.
• On the contrary decrease in price will
reduce p/v ratio and increases break even
point.
20.
EFFECT OF VOLUME CHANGES
Change in
volume
Decrease(2
0%)
budget Increase(2
0%)
Units 80000 100000 120000
Selling
price
20 20 20
Variable
cost
10 10 10
Contributio
n
10 10 10
sales 1600000 2000000 2400000
21.
Variable
cost
800000 1000000 1200000
Contributio
n
800000 1000000 1200000
Fixed cost 400000 400000 400000
Net profit 400000 600000 800000
Percentage
change in
profit
-33.3% - +33.3%
p/v ratio 50% 50% 50%
22.
• A change in volume , not accompanied by
change in the selling price and/or cost, will
not affect p/v ratio.
• As a result the break even point remains
unchanged. Profit will increase with the
increase in volume and will be reduced
with a decrease in volume.
23.
EFFECT OF PRICE AND VOLUME
CHANGES
Change in
price
Decrease
20%
Budget Increase
10%
Change in
volume
Increase
25%
budget Decrease
15%
Units 125000 100000 85000
Selling
price
16 20 22
Variable
cost
10 10 10
contribution 6 10 12
25.
• A change in price is affected by volume. A
price reduction may increase demand of
the product and result in increase in
volume. Profits may increase with a
reduction in price and volume increases
substantially and price rise may reduce
profits if there is fall in volume.
26.
EFFECT OF VARIABLE COST
CHANGES
Change in
variable
cost
Decrease
20%
budget Increase
20%
Units 100000 100000 100000
Selling
price
20 20 20
Variable
cost
8 10 12
Contributio
n
12 10 8
28.
• p/v ratio 60%,50%,40%.
• An increase in variable cost will lower the
PE ratio , push up the break even point
and reduces profit. If the variable cost
decreases P/V ratio increases and break
even point will be lowered and profits will
rise.
29.
EFFECT OF CHANGE IN FIXED
COSTS
Change in
fixed cost
Decrease
25%
budget Increase
25%
Units 100000 100000 100000
Selling
price
20 20 20
Variable
cost
10 10 10
Contributio
n
10 10 10
Sales cost 2000000 2000000 2000000
30.
Variable
cost
1000000 1000000 1000000
Contributio
n
1000000 1000000 1000000
Fixed cost 300000 400000 500000
Net profit 700000 600000 500000
Percentage
change in
profit
+16.67% - -16.67%
31.
• P/V ratio : 50%,50%,50%
• A change in fixed cost does not influence
P/V ratio. Other factors remaining
unchanged ,a fall in fixed cost will lower
break even point and increases profit
• If total fixed cost is 152000 calculate BEP
and profit.
32.
COST VOLUME PROFIT ANALYSIS FOR MULTI
PRODUCT FIRM
Product
x y z
Sales 200000 300000 500000
Variable
cost
120000 210000 350000
33.
Sales
mix
X
20%
Y
30%
Z
50%
Total
100%
Sales
revenue
200000 300000 500000 1000000
Variable
cost
120000 210000 350000 680000
Contribut
ion
80000 90000 150000 320000
Fixed
cost
152000
34.
Net profit 168000
P/V ratio 40% 30% 30% 32%
BEP 152000/
0.32=47
5000
35.
UTILITY OF CVP ANALYSIS
• It is simple device to understand
accounting data.
• It is a useful diagnostic tool.
• It provides basic information for further
profit improvement studies.
• It is useful method for considering risk
implementation of alternative actions.
36.
LIMITATION OF CVP ANALYSIS
• It is difficult to separate cost in to fixed and
variable components.
• It is not correct to assume that total fixed cost
would remain unchanged over the entire range
of volume.
• The assumption of constant selling price and
variable cost is not valid.
• It is difficult to use break even analysis
37.
• For multi product firm.
• The break even analysis is a short run
concept and has a limited use in long
range planning.
• The break even analysis is static tool.
38.
• BEP analysis is a specific way of studying the
interrelationship between cost, volume and
profit.
• BEP analysis establishes relationship between
revenues, cost with respect to volume,
• The significant aspect of CVP analysis is to
examine the effects of change in cost, volume
and price on profits.
39.
Break even chart
• This chart portrays a pictorial view of the
relationship between cost, volume, profit.
• The BEP indicated in the chart will be one
at which total cost line and total sales lines
intersects.
40.
• Estimated sales : 20,00,000
• Less :Variable cost : 12,00,000
• Contribution : 8,00,000
• Less : Fixed cost : 4,00,000
• Net profit : 4,00,000
41.
• Intersection between sales and total cost
is the BEP.
• The angle formed by intersection of sales
and total cost line is known as angle of
incidence. Larger the angle lower will be
the BEP and vice versa.
• Margin of safety : the excess of actual or
budgeted sales over break even sales
42.
• Margin of safety indicates the extent to which
sales may fall before the firm suffers a loss.
• A low margin of safety may result for a firm
which has low contribution.
• If both margin of safety and P/V ratio are low the
firm must think of increasing selling price
43.
• Margin of safety = sales- BE sales/sales
• BE sales = fixed cost/contribution
44.
Limitations
of break even analysis
• Break-even analysis is only a supply side (i.e. costs only) analysis, as it tells
you nothing about what sales are actually likely to be for the product at
these various prices.
• It assumes that fixed costs (FC) are constant
• It assumes average variable costs are constant per unit of output, at least in
the range of likely quantities of sales. (i.e. linearity)
• It assumes that the quantity of goods produced is equal to the quantity of
goods sold (i.e., there is no change in the quantity of goods held in inventory
at the beginning of the period and the quantity of goods held in inventory at
the end of the period).
• In multi-product companies, it assumes that the relative proportions of each
product sold and produced are constant (i.e., the sales mix is constant).
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