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COST-VOLUME-PROFIT ANALYSIS

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COST-VOLUME-PROFIT ANALYSISCost-volume-profit (CVP) analysis is used todetermine how changes in costs and volumeaffect a company's operating income and netincome. In performing this analysis, there areseveral assumptions made, including:

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.

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Cost-volume-profit analysis (CVP), or break-evenanalysis, is used to compute the volume level atwhich total revenues are equal to total costs.When total costs and total revenues are equal,the business organization is said to be "breakingeven."Total cost = Total fixed cost + Total variable cost There are a number of costs that vary or change,but if the variation is not due to volume changes,it is not considered to be a variable cost.Examples of variable costs are direct materialsand direct labor. Total fixed costs do not vary asvolume levels change within the relevant range.Examples of fixed costs are straight-linedepreciation and annual insurance charges.

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CONTRIBUTION AND P/V RATIO Key calculations when using CVP analysis are the

contribution margin and the profit volume ratio .The contribution margin represents the amount of income or profit the company made beforededucting its fixed costs. Said another way, it is theamount of sales available to cover (or contributeto) fixed costs. The contribution margin is salesrevenue minus all variable costs. It may becalculated using rupees or on a per unit basis.

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CONTRIBUTION

Sales-variable costFixed cost + profit

Fixed cost loss

(Sales at BEP in Rs. * PV ratio) + Profit

(Sales at BEP in units * Contribution /unit) + Profit

(Margin of safety in Rs.*P/V ratio)+ fixed cost

(Margin of safety in units * Contribution /unit) + fixed cost

Profit/ Margin of safety in %

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Profit Volume (P/V) RATIO

Contribution/Sales*100

Change in profit/Change in sales*100

Fixed cost/B.E.P. in Rs.*100

Profit/Margin of Safety in Rs.*100

100-Variable cost as a % of sales

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BREAK EVEN POINT

The break-even point represents the level of sales

where net income equals zero. In other words, thepoint where sales revenue equals total variablecosts plus total fixed costs, and contribution marginequals fixed costs.

Break-even point in rupeesBREAK EVEN SALES = FIXED COST / PV RATIO

Break-even point in unitsBREAK EVEN POINT = FIXED COST / CONTRIBUTION PER UNITBEP= Actual sales-Margin of safety

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TARGETED INCOME CVP analysis is also used when a company is trying to

determine what level of sales is necessary to reach aspecific level of income, also called targeted income . Tocalculate the required sales level, the targeted income isadded to fixed costs, and the total is divided by the

contribution margin ratio to determine required salesdollars, or the total is divided by contribution margin perunit to determine the required sales level in units.

REQUIRED SALES IN RUPEES(FIXED COST + DESIRED PROFIT)/PROFIT VOLUME RATIO REQUIRED SALES IN UNITS(FIXED COST + DESIRED PROFIT)/CONTRIBUTION PER UNIT

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MARGIN OF SAFETY Margin of safety is the difference between theexpected (or actual) sales level and the breakeven saleslevel. Margin of safety represents the strength of thebusiness. It enables a business to know what is theexact amount it has gained or lost and whether theyare over or below the break even point. It can beexpressed in the equation form as follows:Margin of Safety

Expected (or) Actual Sales Level (quantity or rupeeamount) - Breakeven Sales Level (quantity or rupeeamount)

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MOS as % of sales= MOS/Actual Sales*100MOS= Profit/PV Ratio

MOS= 100- BEP in %Profit= MOS * PV RatioProfit= Actual sales*MOS Ratio*PV Ratio

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Profit

Sales- Total costSales-variable cost-fixed cost

Contribution-fixed costMOS in Rs.* PV ratio

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Fixed Cost

Sales - Variable cost - profit Sales - Variable cost + loss

Contribution-Profit Contribution + Loss Total cost Variable cost Sales at BEP in Rs. * PV ratio

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Utility of CVP Analysis

Fixation of Selling Price: The cost of the product andthe desired profitability are two important factorswhich govern the fixation of selling price.

Maintaining a desired level of profit: In the face of price cuts, in case the demand for the companysproduct is elastic, the minimum level of profit can be

maintained by pushing up the sales. The volume of such sales can be found out by the marginal costingtechnique.

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Accepting of price less than total cost: Sometimesprices have to be fixed below the total cost of the

product. In such a scenario, a price less than the totalcost but above the marginal cost may be acceptablebecause in such periods any material contributiontowards recovery of fixed costs is acceptable rather

than no contribution at all.Decisions involving alternative choices: The techniqueof marginal costing helps in making decisions involvingalternative choices ex. Discontinuance of a productline, changes of sales mix, make or buy, own or lease,expand or contract etc. The technique used isdifferential costing, which is an extension of thetechnique of marginal costing.

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1. From the following information calculate: (i) P/V Ratio(ii) Fixed cost (iii) sales volume to earn a profit of Rs.40,000.

Given:i. Sales: Rs.1,00,000ii. Variable cost : 70% of sales

iii. Profit : Rs.10,000.

2. In a period sales amount to Rs.2,00,000 and net profitRs.20,000. Fixed overheads are Rs.30000. Find out:

(i) P/V Ratio (ii) Profit when sales will be Rs.3,00,000 (iii)Sales to earn a profit of Rs.30,000 (iv) Contribution whensales will be Rs.1,50,000 (v) Variable cost for sales of Rs.3,00,000

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3. From the following information, calculate:(i) P/V Ratio (ii) B.E.P. (iii) M.O.S.Total Sales Rs.3,60,000Selling price per unit Rs.100Variable Cost per unit Rs.50Fixed Cost Rs.1,00,000

4. Three Firms X, Y, Z manufacture the same product.The selling price is Rs.8 per unit. The fixed costs for

firms are Rs.80000, Rs.2,00,000 and Rs.3,30,000respectively, while variable cost per unit is Rs.6, Rs.4and Rs.3. Determine B.E.P. for all the firms. How muchprofit will be earned if each firm sells 80,000 units?

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5. You are given the following information:Period Sales Profit (+) Loss(-)August 2004 90,000 -10,000

September 2004 1,30,000 +10,000Calculate: (a) P/V Ratio (b) Fixed Overhead (c) Level of activity if profit is 25000.

(d) Expected profit if sales is Rs.180000 (e) B.E.P.

6. A company gives you following information about itsproduct:

Year Sales Profit2003 15000 4002004 19000 1150

Calculate:(a) P/V Ratio (b) Level of activity if profit is 2000.(c) Expected profit / loss if sales is Rs.12000 (d) B.E.P.

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7. The statement of profit of XYZ Ltd. are as under:Particulars Rs.

Sales (16000 units) 3,20,000Less: Variable cost (Rs.15 per unit) 2,40,000

Contribution 80,000

Less: Fixed cost 60,000

Profit 20,000Calculate P/V Ratio and then on the basis of P/V Ratio, Determine: Sales for 40% P/V Ratio. Break even point Contribution when sales amount to Rs.2,56,000. MOS when profit is Rs.4,000. Variable cost when sales amounts to be Rs.2,56,000. If the selling price per unit is reduced to Rs.16, the new sales volume tooffset this price reduction.

Sales to earn a profit of Rs.40,000.

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8. The budgeted result for XYZ Ltd. include the following:Product Sales Variable cost as % of

sales

A 50,000 60%B 40,000 50%C 80,000 65%D 30,000 80%

E 44,000 75%Fixed overhead for the period are Rs.90,000.

Produce a statement showing the amount of profit / lossexpected. Suggest a change in the sales volume of each product whichwill result in a profit of Rs.50,000, assuming that the sales of only one product can be increases at a time.

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9. A firms sale for the month of March was Rs.4,00,000 and itmade a profit of Rs.40,000. For the month of April sales wereRs.500000 and profit is increased to Rs.60,000.Determine: (a) Variable cost as % of price

(b) Fixed cost(c) B.E.P.(d) Amount of sales if desired profit is Rs.80,000 .

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10. Total cost of a firm at monthly sale of 59,000 units wasRs.2,28,000, while that at 63,000 units under the samecondition would have been Rs.2,36,000. Sale proceeds for

59,000 units were Rs.2,36,000.(a) At what level of sales per month will the profit be zero.(b) If the firm wants to earn a profit of Rs.40,000, whatchanges will be necessary in the following, each taken

separately:(i) unit sold (ii) selling price per unit(iii) non-variable exp (iv) variable cost per unit(c) How will present profit be affected if the firm:(i) Decreases selling price by 5%.(ii) Reduces variable cost by 5%.(iii) Increases volume of sale by 10% and increases non-variable cost by 2% - Both taken together.