SAN PEDRO COLLEGE

12 C. Guzman Street, 8000 Davao City, Philippines

Master of Arts in Hospital Administration

Third Trimester, SY 2019-2020

ACCOUNTING & FINANCIAL MANAGEMENT

LESSON 3 – COST-VOLUME-PROFIT (CVP) ANALYSIS

CVP ANALYSIS

It helps financial managers to cope up with many planning decisions involving on

how the company deals with its profit and costs changes relative to changes in
volume.

FACTORS AFFECTING CVP ANALYSIS

1. Variable Costs – are costs that vary in direct proportion to the changes in volume
of production within a relevant range of activity. Examples are direct materials,
direct labor and sales commissions.
2. Fixed Costs – are costs not affected by changes in volume within a relevant range
of activity. Examples are depreciation of property and rental.
3. Selling Price
4. Volume

BASIC ASSUMPTIONS FOR CVP & BREAK-EVEN ANALYSIS

1. The behavior of both sales and expenses is linear throughout the entire relevant
range of activity.
2. All costs are classified as fixed or variable.
3. There is only one product.
4. Inventories do not change significantly from period to period.
5. Volume is the only factor affecting variable costs.

QUESTIONS ANSWERED BY CVP ANALYSIS

1. What sales volumes is required to break-even?

2. What sales volume is necessary in order to earn a desired profit?
3. What profit can be expected on a given sales volume?
4. How would changes in selling price, variable costs, fixed costs and output affect
profits?
CONCEPT OF CONTRIBUTION MARGIN

For accurate CVP analysis, a distinction must be made between costs as being either
variable or fixed. Mixed costs must be separated into their variable and fixed
components. In order to compute later the break-even point and perform various
CVP analysis, note the following important concepts.

Contribution margin (CM) – is the excess of sales (S) over variable costs (VC) of the
product. It is the amount of money available to cover fixed costs and to generate
profits. Thus, it is expressed as:

CM = S - VC

CM per unit – is the excess of unit selling price over the unit variable cost,
symbolically shown as:

CM per unit = SP per unit – VC per unit

CM ratio – is the contribution margin as a percentage of sales.

CM Ratio = CM or S – VC or 1 – VC
S S S

Illustration: Consider the following data for Company A:

Per Unit Total Percentage
Sales (1,500 units) P25 P37,500 100%
Less: Variable costs 10 15,000 40%
Contribution margin P15 P22,500 60%
Less: Fixed costs 15,000
Net income P 7,500

From the data listed above, how much is the CM, CM per unit, and
CM ratio?

Solution: CM = P37,500 – 15,000 = P22,500

CM per unit = P25 – 10 = P15
CM ratio = P22,500 = 60%
P37,500
or 1 – 40% = 60%

BREAK-EVEN ANALYSIS

The break-even point, the point of no profit and no loss, provides managers with
insights into profit planning. It can be computed using the following formulas:
 Break-even point (BEP) in units = Fixed Costs
CM per unit

Break-even point (BEP) in pesos = Fixed Costs

CM ratio

Using the same illustration above, compute the break-even point in units and in
pesos.

Solution: BEP (units) = P15,000 = 1,000 units

P15
BEP (pesos) = P15,000 = P25,000
60%
To prove:
Sales (1,000 units x P25) P25,000
Less: Variable costs (1,000 units x P10) 10,000
Contribution margin P15,000
Less: Fixed costs 15,000
Break-even (no profit, no loss) P 0

TARGET INCOME, VOLUME AND MARGIN OF SAFETY

Besides determining the break-even point, CVP analysis determines the sales
required to attain a particular income level or target net income, expressed as:

Target sales in units = Fixed Costs + Target Profit

CM per unit

Target sales in pesos = Fixed Costs + Target Profit

CM ratio

or Fixed Costs
CM ratio – Profit ratio

Using the same data given, compute the target sales in units and in pesos assuming
the company wishes to attain:

Case 1: A target income of P15,000

Solution: Target sales (units) = P15,000 + 15,000 = 2,000 units

P15

Or Target sales (pesos) = P15,000 + 15,000 = P50,000

60%
 To prove:
Sales (2,000 units x P25) P50,000
Less: Variable costs (2,000 units x P10) 20,000
Contribution margin P30,000
Less: Fixed costs 15,000
Target income P15,000

Case 2: A target income of 20% of sales

Solution: Target sales (units) = P15,000 = 1,500 units

P15 – (P25 x 20%)

Or Target sales (pesos) = P15,000 = P37,500

60% - 20%

To prove:
Sales (1,500 units x P25) P37,500
Less: Variable costs (1,500 units x P10) 15,000
Contribution margin P22,500
Less: Fixed costs 15,000
Target income P 7,500

MARGIN OF SAFETY

It is a measure of difference between the actual level of sales and the break-even
sales. It is the amount by which sales may drop before losses begin, and is expressed
as a percentage of budgeted sales. It is often used as a measure of risk. The large
the ratio, the safer is the situation, since there is less risk of reaching the break-even
point.

Margin of safety = Budgeted sales – Break-even sales

Budgeted sales

Assume that a company projects sales of P30,000 with a break-even sales level of
P25,000. The expected margin of safety is:

Solution: Margin of safety = P30,000 – P25,000 = 16.7%

P30,000
QUIZ – COST-VOLUME-PROFIT ANALYSIS

Multiple Choice:

1. Which of the following is NOT a fixed cost?

a. Property taxes
b. Salary of plant manager
c. Direct materials cost
d. Straight-line depreciation

2. The elements of CVP analysis include all of the following, except:

a. Total fixed costs
b. Unit variable costs
c. Volume or number of units
d. Relevant costs

3. It is the level of output or sales at which total revenues equal total costs, that is, the
point at which operating income is zero.
a. Indifferent point
b. Break-even point
c. Sangley point
d. Order point

4. CVP analysis is most essential in the determination of the:

a. Relationship between revenues and costs at various levels of operations
b. Volume of operation in order to break-even
c. Variable costs necessary to equal fixed costs
d. Production level that is equal to sales

5. Which is not correct? At break-even point,

a. Profit equals zero
b. Gross profit equals zero
c. Sales equals total costs
d. Fixed cost equals contribution margin

6. The margin of safety is a key concept in CVP analysis. Which is not correct about
margin of safety?
a. It is the amount of sales which may be reduced without resulting into a loss.
b. It is the difference between budgeted sales and break-even sales.
c. It may be expressed in terms of units or in pesos.
d. Its presence means that the company earns profit.

7. The alternative that would increase the contribution margin per unit the most is a:
a. 10% decrease in unit variable cost
b. 10% increase in selling price
c. 10% decrease in fixed cost
d. 10% decrease in selling price

8. Which of the following statements is CORRECT with respect to variable cost per unit,
within the relevant range?
a. It will increase as production decreases.
 b. It will decrease as production decreases.
c. It will remain the same as production levels change.
d. It will decrease as production increases.

9. Which of the following statements is CORRECT with respect to total fixed costs,
within the relevant range?
a. They will remain the same as production levels change.
b. They will increase as production decreases.
c. They will decrease as production decreases.
d. They will decrease as production increases.

10. Which of the following will lower the breakeven point assuming no other changes?
a. A decrease in the sales price per unit
b. An increase in total fixed costs
c. An increase in the variable costs per unit
d. An increase in the sales price per unit
CASE PROBLEMS

Case 1

Assume for both companies:

Company A Company B
Selling price per unit P100 P50
Variable costs per unit P60 P35
Fixed costs P24,000 P60,000

Required: Compute for the following:

Company A Company B
Break-even point in units _________ _________
Break-even point in pesos _________ _________
Target sales in units if desired
income is P3,000 _________ _________
Target sales in pesos if desired
loss is P6,000 _________ _________
Margin of safety in pesos if
actual sales is P100,000 for Co.
A and P300,000 for Co. B _________ _________

Case 2

Nessy Company is one of several suppliers of part X to an automobile manufacturing

firm. Orders are distributed to the various die-casting components on a fairly even
basis; however, the sales manager of the company believes that with a reduction in
price, he could secure a 30% increase in units sold. The general manager has asked
you to analyze the sales manager’s proposal and submit your recommendation. The
following data are available:
Present Proposed
Unit price P2.50 P2.00
Unit sales 200,000 units Plus 30%
Variable costs P350,0000 Same unit variable cost
Fixed costs P120,000 P120,000
Net income P30,000 ?

Required: Compute for the following:

a. Net income or loss on the sales manager’s proposal
b. Target sales in units under the proposed price to make the original
P30,000 net income