Cost-volume-profit (CVP) analysis is a method of cost accounting that looks at the impact that varying levels of costs and volume have on operating profit.

1. ANALYZING COST-VOLUME-PROFIT
RELATIONSHIPS
MANAGERIALACCOUNTING
Chapter 5 (17th edition)
Presentedby:UzairAhmedandImanSyeda
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2. Cost-volume-profit analysis
Defining CVP analysis and its significance in
understanding the interplay between costs,
volume, and profits. Exploring the key
components of CVP analysis, including
contribution margin and break-even point.
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3. INTRODUCTION
Cost-volume-profit(CVP) analysis helps managers to make
important decisions:
 What services and products to offer?
 What prices to charge?
 What marketing strategy to use?
 What cost structure to maintain?
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4. The Basics Of Cost Volume Profit Analysis
 Its primary purpose is to estimate how profits are
affected by the following five factors:
1. Selling prices
2. Sales Volume
3. Unit variable costs
4. Total fixed costs and
5. Mix of products sold
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5. CONTRIBUTION MARGIN
 Contribution margin is the amount
remaining from sales revenue after
variable expenses have been
deducted.
 contribution margin is used first to
cover the fixed expenses, and then
whatever remains goes toward
profits. 5

6. A higher contribution margin ratio indicates that a
larger portion of sales revenue is available to cover fixed
costs and generate profit. This is crucial for businesses
aiming to maximize their profitability.
Interpreting Contribution Margin Ratio
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7. Implementing strategies to reduce variable costs,
increasing selling prices, and focusing on high-
margin products can help improve the contribution
margin ratio and ultimately drive higher
profitability.
Strategies to Improve Contribution Margin Ratio
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8. CVP Relationships in Equation Form
 Profit = (Sales − Variable expenses) − Fixed expenses
 Profit = (P × Q − V × Q) − Fixed expenses
 It is often useful to express the simple profit equation in terms of the unit
contribution margin (Unit CM) as follows:
 Unit CM = Selling price per unit − Variable expenses per unit = P − V
 Profit = (P × Q − V × Q) − Fixed expenses
 Profit = (P − V) × Q − Fixed expenses
 Profit = Unit CM × Q − Fixed expenses
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9. CVP Relationships in Graphic Form
 Horizontal red line shows Total fixed
expense.
 The blue line shows the total expense.
 The red line starting from zero shows
the total revenue.
 The intersection of total revenue and
total expense shows the break-even
point.
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10. Contribution Margin Ratio (CM Ratio) and the
Variable Expense Ratio
 CM ratio = Contribution margin /sales
 Per unit basis:
 CM ratio = Unit contribution margin/unit selling price
 Variable expense ratio = Variable expenses/sales
 Per Unit basis:
 Variable expense ratio =Variable expense per unit/Unit selling price
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11. The contribution margin ratio and the variable expense ratio
can be mathematically related to one another:
 CM ratio = Contribution margin/sales
 CM ratio=Sales-Variable expenses/Sales
 CM ratio = 1 − Variable expense ratio
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12. Applications of the Contribution Margin Ratio
 The CM ratio shows how the contribution margin will be
affected by a change in sales volume.
 Contribution margin is expressed in equation form as:
 Change in contribution margin = CM ratio × Change in
sales
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13. Applications of the Contribution Margin
Ratio
 Shows how the contribution margin will be affected by a change in
sales volume.
 Acoustic Concepts’ CM ratio of 40% means that for each dollar
increase in sales, total contribution margin will increase by 40 cents
($1 sales × CM ratio of 40%). Net operating income will also
increase by 40 cents, fixed costs are not affected by the increase in
unit sales.
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14. Change in contribution margin = CM ratio × Change in
sales
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15. The relation between profit and the CM ratio
Profit = (Sales − Variable expenses) − Fixed expenses
Profit = Contribution margin − Fixed expenses
Profit = Contribution margin × Sales − Fixed expenses
Profit = CM ratio × Sales − Fixed expenses
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16. Thebreak-even pointis wheretotalrevenueequalstotalcosts,resulting
in zeroprofitor loss.Understanding this point is crucialfordecision-
making.
Unit sales to break even = Fixed expenses
Unit CM
Break-even analysis
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17. Target Profit Analysis
• Key uses of CVP analysis
• we estimate the level of sales needed to achieve a desired target
profit.
• Unit sales to attain the target profit = Target profit +Fixed
expenses/unit CM
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18. MARGIN OF SAFETY
The margin of safety is the excess of budgeted or actual sales dollars over the
breakeven sales dollars. It is the amount by which sales can drop before
losses are incurred.
The margin of safety in dollars = Total budgeted (or actual)
sales− Break‐even sale
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19. Cost Structure
In Cost Structure which cost structure is better—high variable costs and low fixed costs,
or the opposite? No single answer to this question is possible; each approach has its
advantages.
Depends on many factors, including the long-run trend in sales, year-to-year fluctuations in the
level of sales, and the attitude of the owners toward risk. 19

20. Profit Stability
If sales are expected to exceed $100,000 in the future, then
Sterling Farm probably has the better cost structure. The reason is
that its CM ratio is higher, and its profits will therefore increase
more rapidly as unit sales increase, assume that each farm
experiences a 10 percent increase in unit sales without any
increase in fixed costs.
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21. Sterling Farm has experienced a greater increase in net operating income
due to its higher CM ratio even though the increase in unit sales was the
same for both farms 21

22. Operating Leverage
 Operating leverage is a measure of how sensitive net operating income
is to a given percentage change in unit sales. Operating leverage acts
as a multiplier. If operating leverage is high, a small percentage
increase in unit sales can produce a much larger percentage increase in
net operating income.
 The degree of operating leverage is a measure, at a given level of
sales, of how a percentage change in sales volume will affect profits.
 Degree of operating leverage = Contribution margin
Net operating income
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23. Sales Mix
The term sales mix refers to the relative
proportions in which a company’s products are
sold. The idea is to achieve the combination, or
mix, that will yield the greatest profits. A shift in
the sales mix from high-margin items to low-
margin items can cause total profits to decrease
even though total sales may increase.
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24. Sukkur IBA University – Kandhkot Campus has
been established to offer access to quality
education to the people of underprivileged areas of
Pakistan. With its geographical importance in
Kandhkot city, the campus provides easy access to
students from south Punjab, northern Sindh, and
southeast Baluchistan. The campus offers
admission in various programs including
undergraduate, foundation semester, summer
program, and short courses.
Sukkur
IBA University Kandhkot-
Campus
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25. Thanks!
for your kind attention
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