Lecture 15 CVP analysis_ Breakeven point.pptx

CVP analysis, Break-even point

Learning Outcomes
Comprehend the significance of Break
Even Analysis for a business
Understand the concept and
calculations of Contribution
Understand the concept and
calculations of PV ratio and margin of
safety

CVP analysis
• Important tool of profit planning
• Provides information on
• behaviour of cost in relation to volume
• Break even points
• Sensitivity of profits due to change in output
• Amount of profit for projected sales
• quantity of production and sales for targeted
profit
cost volume profit

• https://www.youtube.com/watch?v=LDEyu1T
R0Rs

CVP Analysis
The aim of an undertaking is to earn profit. Profit
depends upon a large number of factors, the
most important of which are the costs of the
manufacturer and the volume of sales effected.

CVP Analysis
Both these factors are interdependent – volume
of sales depends upon the volume of
production, which in turn is related to costs.
Cost again is the result of the operation of a
number of varying factors such as: 1. Volume
of production, 2. Product mix, 3. Internal
efficiency, 4. Methods of production, 5. Size of
plant, etc.

Of all these, volume is perhaps the largest single
factor which influences costs which can basically be
divided into fixed costs and variable costs.
As profits are affected by the interplay of costs and
volume, the management must have, at its
disposal, an analysis that can allow for a
reasonably accurate presentation of the effect of
a change in any of these factors which would
have on profit performance.
CVP Analysis

CVP Analysis
• Cost-volume-profit analysis furnishes a picture
of the profit at various levels of activity. This
enables management to distinguish between
the effect of sales volume fluctuations and the
results of price or cost changes upon profits.
This analysis helps in understanding the
behaviour of profits in relation to cost and
sales.

• How can we do CVP analysis

Break even analysis
• The solution is…….

• Widely used to study CVP analysis
• Narrow interpretation-
• A system of determination of level of
production/sales at which cost will be equals
to selling price
• Broad interpretation-
• System which determines probable profits at
any level of activity
Break even analysis

Poll
• Break-even analysis is also called?
• (a) Business Analysis
• (b) Unit sales
• (c) Cost-Volume-Profit analysis
• (d) None of the above

⦁ In economics & business, specifically cost accounting,
the break-even point (BEP) is the point at which cost or
expenses and revenue are equal: there is no net loss or
gain, and one has "broken even".
⦁ Total cost = Total revenue = B.E.P.
Break even point

Poll
• The break-even point can be defined as?
• (a) The level of activity at which there is
neither profit nor loss
• (b) The level of activity where cash flow is zero
• (c) The level of activity where profits equal
fixed costs
• (d) The level of activity where variable costs
are covered by sales revenue

In order to calculate how profitable a product will be, we must
firstly look at the Costs Price and Revenue involved.
⦁ There are two basic types of costs a company incurs.
• Variable Costs
• Fixed Costs
⦁ Variable costs are costs that change with changes in
production levels or sales. Examples include: Costs of
materials used in the production of the goods.
⦁ Fixed costs remain roughly the same regardless of
sales/output levels. Examples include: Rent, Insurance and
Wages
BREAK EVEN ANALYSIS terms

⦁ Unit Price:
p
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d
a
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c
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u
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s
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o
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neycharged to the customer for each unit of a
⦁ Total Cost:
The sum of the fixed cost and total variable cost for any given level of
production.
(Fixed Cost + Total Variable Cost )
⦁ Total Variable Cost:
The product of expected unit sales and variable unit cost.
(Expected Unit Sales * Variable Unit Cost )

⦁ Total Revenue:
The product of expected unit sales and unit price.
(Expected Unit Sales * Unit Price )
⦁ Profit/ loss
The monetary gain or loss resulting from revenues after
subtracting all associated costs. (Total Revenue - Total Costs)

• Contribution margin (CM) is the amount by
which a product's sales exceeds its
variable costs. It is the net amount
available to cover the fixed costs and
target profit.
• Total Contribution Margin = Sales - Total
Variable Costs
or
• TC= S-VC
Contribution

⦁ For example, suppose that your fixed costs for producing
100,000 product were 30,000 Rs a year.
⦁ Your variable costs are 2.20 R.s materials, 4.00 R.s labor, and
0.80 Rs overhead, for a total of 7.00 R.s per unit.
⦁ If you choose a selling price of 12.00 Rs for each product, then:
⦁ BEP= TFC/S-VC
⦁ 30,000(TFC) divided by [12.00(P) - 7.00(V)] equals 6000 units.
⦁ This is the number of products that have to be sold at a selling
price of 12.00 Rs before your business will start to make a profit.
EXAMPLES

Poll
• The break-even point in units is represented
by the equation?
• (a) Fixed costs / Variable costs
• (b) Fixed costs / selling price per unit
• (c) (Sales revenue - Fixed costs) / Contribution
per unit
• (d) Fixed costs / Contribution per unit

Poll
• A company has fixed costs of Rs. 50,000 and
variable costs per unit of output of Rs. 8. If its
sole product sells for Rs. 18, what is the break-
even quantity of output?
• (a) Rs. 2,500
• (b) Rs. 5,000
• (c) Rs. 1,500
• (d) Rs. 7,500

Practical Example
• Total fixed cost= 12000
• Selling price= Rs12 per unit
• Variable cost = Rs9 per unit
Solution:
(i) Contribution= S-V= 12-9= Rs.3 per unit
(ii) P/V ratio= C/S*100= 3/12*100= 25%
(iii) Break even point (in units) = F/C
= 12000/3= 4000 units
Break even point (in rupees) = F/C*sales
=12000/3*12 = Rs. 48000

⦁ Margin of safety represents the strength of the
business.
⦁ It measures difference between total sales and break
even sales
⦁ It enables a business to know what is the exact
amount it has gained or lost and whether they are
over or below the break even point.
⦁ Margin of safety = profit / PV ratio OR
⦁ Margin of safety = actual sales – BEP sales
⦁ Margin of safety% = (current output -
breakeven output)/current output × 100
MARGIN OF SAFETY

• https://www.youtube.com/watch?v=VMd68H
nPC7s

Example
• Suppose company’s break even point sales are
800 rs but company has sold 1000rs product
so margin of safety is-
A. 1800
B. 200
C. 800
D. 1000

Other Example
• A company earned profit of 30000 during 2020
and VC is 8 and selling price is 10 per unit find out
MoS
• margin of safety = profit / PV ratio
• PV ratio= contribution/sale *100
• Contribution= selling price – variable cost
• =10-8= 2
• PV ratio= 2/10*100= 20
• Margin of safety = 30000/20%= 150000

Margin of Safety
Margin of safety indicates soundness of a business.
When margin of safety is large, it means the
business can still make profits even after a serious
fall in prices. Higher level of safety margin
indicates low fixed costs.

Practical Example
Company X Company Y
Actual Sales 1,20,000 60,000
Less: Break even
point
40,000 40,000
Margin of safety 80,000 20,000
Margin of safety
(% of sales)
80,000/1,20,00
0*100
20,000/60,000*1
00
=66 2/3% =33 1/3 %
Which company is considered to be sound ????

Profit-Volume (P/V) Ratio
The profit volume ratio better known as contribution
margin to sales ratio expresses the relationship of
contribution to sales.
 This ratio is also known as marginal income ratio, or
variable profit ratio. P/V ratio, usually expressed as a
percentage, is the rate at which profits increase with the
increase in volume.
When P/V ratio is high it indicates the high profit margin.
A low P/V ratio indicates low profit margin. In the cases
of low margin, the company has to either increase the
selling price to improve the PV ratio or increase the sales
turnover to earn satisfactory profit in the business. The
situation of high PV ratio is called profitable situation.

Profit-Volume (P/V) Ratio
The formulae for P/V ratio are:
P/V ratio = Contribution/Sales
Or
P/V ratio =Sales value - Variable cost/Sales
value

• By transposition, we have:
(i) C = S*P/V ratio
(ii) S = C/P/v ratio
(iii)It can also be calculated as change in
contribution to change in sales.
P/V ratio = Change in Contribution/Change in
sales

Practical Example of P/V ratio
• Sales=Rs. 10,000
• Variable cost= Rs. 8000
• Thus, P/V ratio= C/S
(i) S-V/S= 10000-8000/10,000 *100= 20%
(ii) C= S*P/V ratio
C= 10,000*20%= 2000
The other formula to calculate P/V ratio=
Change in contribution/ Change in sales

Poll
• Determine P/V ratio if Sales is Rs
80,000 and Variable cost is Rs 60,000.
a) 40%
b) 25%
c) 50%
d) None of the above

Importance of P/V Ratio
• It is one of the most imp ratio which indicates rate
at which profit is being earned.
• A high ratio indicates high profitability and vice
versa
P/V ratio can be improved by:
1. Increasing the selling price per unit.
2. Reducing direct and variable costs by effectively
utilizing men, machines and materials.
3. Switching the product to more profitable terms
by showing a higher P/V ratio.

• Determine P/V ratio if Sales per unit is
Rs 10 and Variable cost per unit is Rs 7.
a) 25%
b) 50%
c) 45%
d) 30%

Lecture 15 CVP analysis_ Breakeven point.pptx

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