BASICS OF CVP ANALYSIS IN FINANCIAL ANALYSIS by : DR. T.K. JAIN AFTERSCHO ☺ OL centre for social entrepreneurship sivakamu veterinary hospital road bikaner 334001 rajasthan, india www.afterschoool.tk mobile : 91+9414430763
WHAT IS CVP?? C=COST,V=VOLUME,P=PROFIT THERE IS RELATION BETWEEN THESE, THIS RELATION IS IDENTIFIED IN CVP ANALYSIS
WHAT IS BEP? B=BREAK E=EVEN P=PROFIT the point where there is no profit no loss
WHAT IS BEP? There are two formula : BEP (in units) = fixed cost / contribution per unit BEP (in value) = fixed cost / PV ratio
What is fixed cost? The cost which will remain same whether production is 0 unit or 100 units or 10000 units. Thus this cost has no relation to production volume. Example : if you produce 100 units, your cost of material consumption is Rs. 1000, if you make 1000 units it is 10000, but the rent paid for the office remains the same, Rs. 3000 thus rent is fixed but material is variable cost.
What is variable cost? As we discussed earlier : the cost which varies directly with volume is called variable cost. Material cost, labour cost, power cost, etc. Are variable cost. If production will increase, these costs will also increase
Examples of fixed cost... Rent, salary, office expenses, interest on loan, etc.
Examples of variable expenditure Raw material wages power carriage inward / outward sales commission
What is CONTRIBUTION? Difference of sales price per unit and variable cost per unit is called contribution per unit. Suppose sales price per unit is 10, variable cost per unit is 6, contribution per unit is 4. thus contribution has two components in it = fixed cost + profit
What is PV ratio Contribution as % of sales is called PV ratio contribution is 4, sales price is 10, thus PV ratio is 40%
What is target profit pricing? Here you keep the target profit in mind and price the goods accordingly, so you have to keep the target profit along with fixed cost in all your calculations
What is target profit volume? It's formula is : (fixed cost + targe profit ) / contribution per unit
What is margin of safety? How safe you are ? It is the difference of your present sales to the BEP level. If you are well above BEP level, you are safe. Thus it is measured by comparison to BEP level. Its formula : (sales – BEP) / sales * 100
Example of margin of safety : Your BEP sales is 40000, your present sales is 100000 margin of safety = 60000 margin of safety in % = 60%
Find BEP ? Depreciation = 200,material cost = 500,labour cost = 100, rent = 200, interest = 200, other expenses = 100, sales = 2000, no. Of units = 100 here fixed cost = (rent 200, interest 200, other exp. 100) = 500 variable cost per unit = (500+100)/100 =6 contribution = 20-6, BEP = 500/14=35.7
What is sunk cost? The cost which has already been incurred is ignored in all such calculations, it is called sunk cost. (past cost – cost related to previous years)
What is opportunity cost? It is the best opportunity forgone. It is not taken into account in financial analysis. However, it is taken into account in economic analysis.
Example A toy manufacturer makes an average net profit of Rs. 2.50 per piece on a selling price of Rs. 14.30 by producing and selling 60,000 pieces or 60% of the potential capacity. His cost of sales is: Direct material Rs. 3.50 Direct wages Rs. 1.25 Works overhead Rs. 6.25 (50% fixed) Sales overhead Rs. 0.80 (25% variable) During the current year, he anticipates that his works overhead will go up by 10%, while rates of direct material and direct labour will increase by 6% and 8% respectively. But he has no option of increasing the selling price. Under this situation he obtains an offer for an order equal to 20% of his capacity. The concerned customer is a special customer. What minimum price will you recommend for acceptance to ensure the manufacturer an overall profit of Rs. 1,67,300?
solution Sales (60000 * 14.5) =870000 material (60000*3.5*1.06)=222600 labour (60000*1.25*1.08)=81000 overheads (60000*6.25*1.1=412500 sales (60000*.8) = 48000 profit = 105900 profit left = 61400
Target profit pricing New variables costs : (3.5*1.06) = 3.71, labour (1.25*1.08) = 1.35, overhead = (6.25*1.1*.5)= 3.43, sales overhead=.2 total variable cost =8.69 + target profit 61400/20000 = 3.07 thus target price = 11.76 we have ignored other fixed cost, as it has already been recovered in sale of 60000 routine sales.