Cost-volume Profit Analysis along with illustrations and graphic representation

1. 1
Simmi Agrawal
FCA, ACMA, Ph.D

2. • Understand cost-volume-profit
relationships.
• Learn how to calculate break-even points.
• Explore how cost-volume analysis
supports informed business decisions.

3. Key Concepts

4.  Fixed costs remain constant despite
changes in the level of production.
Cost
Level of Production
4

5. Examples:
 Rent
 Insurance
 Administrative labour
 Wages paid to managers or secretaries (ie
employees not directly involved in the manufacture
of the product or provision of the service).
5

6.  Variable costs change in direct proportion
to changes in the level of production.
Cost
Level Of Production
6

7. Examples
 Materials and parts
 Manufacturing labour
 Machine Time (electricity used by equipment
in the manufacturing process).
7

8. Cost Behavior
• Costs can behave differently in a
business.
• Fixed costs remain constant irrespective of
changes in production or sales volume.
• Variable costs fluctuate with the level of
activity.

9. Contribution Margin
• The contribution margin is a critical
concept.
• It's the difference between sales revenue and
variable costs.
• Contribution Margin = Sales - Variable Costs.
EXAMPLE
 From the following particulars calculate Contribution
 Fixed Expenses Rs 1,50,000 ; Variable Cost per unit Rs 10 ; Selling Price
per unit Rs 15.
 Contribution= Selling Price per unit – Variable Cost per unit
 = Rs 15 – Rs 10 = R 5.

10.  CVP is a model used to determine how
profit will be affected by changes in costs,
selling price or business activity (i.e
volume of sales).
 CVP analysis is a key factor in:
 Pricing products
 Determining marketing strategies
 Assessing viability of a product/event
10

11.  Setting prices for products and services
 New product/service introduction
 Replacing a machine
 Make or buy
 What if analysis

12.  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 Analysis
1. 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 known
5. if more than one product exists, the sales mix is
constant
6. we can ignore the time value of money

13. Profit = SP (x) - VC (x) - FC
 Where SP: Selling Price per unit
VC: Variable Cost per unit
FC: Total Fixed Costs
(x): Number of Units Produced
13

14.  Contribution margin is equal to the difference
between total revenue and total variable costs
Contribution margin per unit
= Selling price - Variable cost per unit
Contribution margin percentage
= Contribution margin per unit / selling price per unit
Revenue Rs200 Rs400 100%
Variable costs 120 240 60%
Contribution margin Rs80 Rs160 40%
Total for
Per Unit 2 units %

15. Packages Sold
0 1 2 25 40
Revenue (Rs) 0 200 400 5,000 8,000
Variable costs (Rs) 0 120 240 3,000 4,800
Contribution margin (Rs) 0 80 160 2,000 3,200
Fixed costs (Rs) 2,000 2,000 2,000 2,000 2,000
Profit (Rs) (2,000) (1,920) (1,840) 0 1,200

16. PV ratio = Contribution Margin per unit/Selling price
- a % figure
- a rate of profitability
Uses of PV ratio:
 1- P/V ratio = Variable cost ratio
 Sales X P/V ratio = Gross contribution
 Determining the sales mix
 BEP = FC / PV Ratio
 [FC+ Target Profit ] / PV ratio gives the volume of
output to be sold to earn a desired level of output

17. improvement in P/V ratio will mean more profit
 reduce variable cost
 increase selling price
 product mix to change in favour of high P/V
ratio products
 Change in FC?

18. From the following particulars calculate P/V Ratio
 Fixed Expenses R 1,50,000 ; Variable Cost per unit
Rs 10 ; Selling Price per unit Rs 15.
 P/V Ratio = Contribution / Sales * 100
 = Rs 5 / Rs 15* 100 = 33%.

19.  Quantity of output where total revenues equal
total costs
 Point where operating income equals zero
Breakeven point in units
= Fixed costs / Contribution margin per unit
= Rs 2,000 / Rs80
= 25 units
Breakeven point in Rupees
= Fixed costs / contribution margin %
= Rs2,000 / 40%
= Rs5,000

20. Rs10,00
0
Rs8,000
Rs6,000
Rs4,000
Rs2,000
Rs0
0 10 20 30 40 50
Units Sold
Total revenues
line
Breakeven
Point
25 units
Operating
income
Operating
loss
Total costs
line

21.  The break even point is particularly useful
when a business is considering entering a
new market or selling a new product.
 The estimated level of risk is compared to
the estimated return.
 The decision to enter a new market or
develop a new product/service will depend
upon the managers degree of risk
aversion.
21

22.  From the following particulars calculate
(i) Break even point in units and in rupees.
(ii) What will be the selling price per unit if the
break even point is brought down to 25,000 units
?
Fixed Expenses R 1,50,000 ; Variable Cost per
unit R 10 ; Selling Price per unit R 15.

23. (i)Break even point (in units) = Fixed Expenses
Contribution per unit
= Rs 1,50,000/ Rs 5 =30,000 units
Break even points (in rupees) = Fixed Expenses
P/V Ratio
= Rs 1,50,000/ 33.33% = Rs 4,50,000
(ii) Break even point (in units) = Fixed Expenses
Contribution per unit
Or Contribution per unit = Fixed Expenses =Rs1,50,000/25000
BEP in units
=Rs 6.
Selling price= Variable cost + Contribution per unit
= Rs 10 + Rs 6 = Rs 16.

24. Margin of Safety
• Margin of safety measures how much
sales can drop before we hit the break-
even point.
• Margin of Safety = Actual Sales - Break-Even
Sales.
 Margin of Safety (M/S) = Profit/P/V Ratio
 Margin of Safety (in units) = Profit / Contribution per
unit

25.  For most firms in the private sector, the main
objective is not to breakeven
 Convert after-tax desired net income to its before-
tax equivalent operating income
Desired operating income
= Desired net income / (1 - tax rate)
Desired Unit Sales
= (Fixed costs + Desired operating income)
/ Contribution margin per unit
Desired Rs Sales
= (Fixed costs + Desired operating income)
/ Contribution margin %