PERFORMANCEMANAGEMENTSession2-Break even Analysis
Topics CoveredCost-Volume Profit AnalysisContributionBreak even pointMargin of safetyBreak even chart
Cost Volume Profit Analysis-CVPEffect on future profit due to changes in fixed cost, variable cost, sale price , quantity and mix.Assumptions: Sales price per unit is constant. Variable costs per unit are constant. Total fixed costs are constant. Everything produced is sold. Costs are only affected because activity changes. If a company sells more than one product, they are sold in the same mix.
Contribution Contribution =Sales value- variable cost Contribution to sales ratio-C/S Ratio (P/V ratio)=Contribution Sales
Break Even Point The break-even point represents the level of sales where net income equals zero. In other words, the point where sales revenue equals total variable costs plus total fixed costs, and contribution margin equals fixed costs. Break even point in units = Fixed Cost Contribution per unit Break even point in sales value= Fixed Cost Contribution ratioOther ways to calculate the BEP:Break even in sales value=Variable cost (percentage)+ fixed cost
Margin Of SafetyA point above which profit will be made.Margin of safety=Budgeted sales-breakeven salesPercentage Margin of safety= Budgeted sales-breakeven sales Projected salesWay to calculate profit:Margin of safety x contribution per unit
Calculation of sales to achieve certainprofitSales in units=Fixed cost + Desired Profit Contribution per unitSales in value=Fixed cost + Desired Profit C/S RatioPage # 102-125
Break Even ChartAxis Y- Cost and revenueAxis X-Level of activityBreak even point- where total cost and sales revenue meets.Fixed cost will be shown as separate line.
Contribution Break Even ChartAxis Y- Cost and revenueAxis X-Level of activityBreak even point- where total cost and sales revenue meets.Variable cost will be shown as separate line.• Difference between sales line and variable cost line is contribution.
Profit Volume ChartSingle line for profit and loss of each activity.Axis Y-Profit and losses.Axis X-Zero Profit or lossPage # 106
Multi product Break Even AnalysisAssumptions: sales mix remain constant.Calculation of weighted average C/S ratio=Total Contribution Total RevenueCalculation of Break even revenue:=Fixed CostWeighted average C/S ratio
Multi product PV Graph• Step1- Calculation of C/S ratio of each product.• Step2-Axis X- Cumulative Sales• Step3- Drawing of contribution per unit on product in order of profitability.• Page #114-127
Sensitivity Analysis• It determines the effects of various changes in the CVP model.• The impact on revenue if variable cost changes, if product mix changes etc.• Page #117
Advantages of break even analysis It indicates the lowest amount of activity necessary to prevent loss. Helps in decision making. Explains the relationship between cost-production volume and returns.
Limitation of break even analysisCVP analysis is based on assumptions about behavior ofRevenue, cost and volume. Change in behavior will later the break even point.CVP chart also get impacted by assumptions.