Cost volume profit
analysis
F. M. Kapepiso
Learning objectives
At the end of the lecture, you should be
able to:
Discuss the purpose and usefulness of CVP
analysis
Apply CVP techniques in both single product
and multiple product contexts
Introduction
This lesson explores how cost behavior, production
levels and sales volume impact an organization's
profit.
Cost volume profit (CVP) analysis is also known as
break-even analysis.
CVP looks specifically at the relationship between the
following five elements: product prices, product mix,
variable cost per unit, total fixed costs and the level of
activity in order to improve profitability.
CVP analysis is concerned with short term-decision
making, therefore it is useful to adopt the variable
costing approach or marginal costing.
Introduction…
Bellow is the marginal costing system of Kirsty Ltd which
manufacturers Uninterrupted Power Supplies (UPSs) for
desktop for the last month.
Rand totals Per unit Percentage
Sales (1650 power suplies) 825 000 ? 100%
Less: Variable costs 495 000 ? ?
Contribution 330 000 ? ?
Less: Fixed costs 130 000
Net profit 200 000
Required: Calculate the following;
1. Contribution expressed in dollar and in percentage
2. Breakeven point in units and dollar
3. Sales units and dollar, assuming that the company would
like to make a target profit of $250 000 for the month
4. Margin of safety in units and percentage
CVP- single product
Cost volume profit analysis is a technique used to determine the
effects of change in selling prices, costs and volume over profits.
There three methods that can be applied in CVP
Using formulae
Using algebraic equation
Using graph
Contribution: known as contribution margin also, it is difference
between revenue and the variable cost of earning that revenue.
Contribution can be expressed on a $ per unit basis or percentage
(profit volume ratio/contribution margin ratio)
Formula:
S-V=C=F+P
(Selling price–Variable cost=Contribution=Fixed costs + Profits)
CMR = Contribution ×100
Sales
CVP- single product…
Break – Even Point: A company breaks even for a period when
sales revenue is equal to total cost of that period or in other
words contribution equals the fixed costs. It can be expressed
in units or in dollar.
BEP (units) =Fixed cost TFC
Contribution per unit OR C
BEP (Dollars): = BEP (units) x selling price per unit
BEP (N$) = Total fixed cost = TFC
CMR CMR
CVP- single product…
Required sales to earn desired net income/ target profit
1. Sales (units) = TFC + Desired profit
C per unit
2. Sales (value) = answer (a) x selling price per unit
OR
TFC + Desired profit
CMR
Remember that DP in above formula is profit before tax.
Therefore, if the target income is net of tax or after tax, the
same should be first converted into profit before tax by using
the following formula.
Profit before tax = Profit after tax / (1 – tax rate*)
* tax rate in decimal form
CVP- single product…
Margin of safety indicates how close the business is operating
to the break even point or the extent to which the current or
expected level of sales can drop before a loss can be incurred.
Can be expressed in units, dollar or percentage.
MS (units) = Budgeted sales in units – break even sales in units
MS (dollar) = budgeted sales in dollar – break even sales in
dollar
MS (%) = budgeted sales units – break even sales units
budgeted sales units
CVP- single product…
Home work
A summary of a manufacturing organization’s budgeted profit
statement for its next financial year, when it expects to be
operating at 75% of capacity, is given bellow.
Sales 9000 units at $32 288 000,00
Less: Direct materials 54 000,00
Direct wages 72 000,00
Production overheads:Fixed 42 000,00
Variable 18 000,00
186 000,00
Gross profit 102 000,00
Less: Admin, selling and distribution costs:
Fixed 36 000,00
Varying with sales volume 27 000,00
63 000,00
Net profit 39 000,00
Cost volume profit analysis…
Home work…
Required:
(a)(i) Calculate the break even point in units and in value.
(ii) Calculate the profit that could be expected if the company
operated at full capacity.
(b)If has been estimated that:
I. If the selling price per unit were reduced to $28, the increased
demand would utilize 90% of the company’s capacity without any
additional expenditure and
II. To attract sufficient demand to utilize full capacity would require
a 15% reduction in the current selling price and a $5,000 special
advertising campaign.
Present a statement showing the effect of the two alternatives and
compare with the original budget. Advice management which plan
should be adopted
CVP analysis-Multi product
Organizations typically produce and sell a variety of products
and services. To perform CVP analysis in a multi-product
organization, a constant product sales mix must be assumed. In
other words, we have to assume that when ever X units of
product A are sold, Y units of product B and Z units of product
C are also sold.
CVP analysis-Multi product
Example 2
Suppose that PL produces and sell two products (M and N).
The M sells for $7 per unit and has a total variable cost of
$2.94 per unit, while the N sells for $15 and has a total
variable cost of $4.50 per unit. The marketing department has
estimated that for every five units of M sold, one unit of N will
be sold. The organization’s fixed cost total $36,000 and
budgeted sales revenue for next period is $74,000 in the
standard mix.
Required: calculate
BEP using average contribution to sales ratio and BEP in
units
Target profit and margin of safety
CVP analysis-Multi product…
Contribution to sales ratio
Can be calculated in the following steps
1. Calculate revenue per mix (sales x mix)
2. Calculate contribution per mix ( Contribution x mix)
3. Calculate average C/S ratio
4. Calculate break even (total)
5. Calculate revenue ratio mix
6. Calculate break even in dollar for each mix
CVP analysis-Multi product…
Break even point for multi product
Can be calculated in the following steps
1. Calculate contribution per unit
2. Calculate contribution per mix ( Contribution x mix)
3. Calculate break even point for number of mixes
4. Calculate break even point in units of each product (step 3
x mix)
5. Calculate break even in dollar for each mix (unit x selling
price)
CVP analysis-Multi product…
Target profit for multi product
Can be calculated in the following steps
1. Calculate revenue per mix (sales x mix)
2. Calculate contribution per mix ( Contribution x mix)
3. Calculate average C/S ratio
4. Calculate required total revenue
5. Calculate revenue ratio mix
6. Calculate required sales for each product
CVP analysis-Multi product…
Margin of safety
Can be calculated in the following steps
1. Calculate contribution per unit
2. Calculate contribution per mix ( Contribution x mix)
3. Calculate break even point for number of mixes
4. Calculate break even point in units of each product (step 3
x mix)
5. Calculate break even in dollar for each mix (unit x selling
price)
6. Calculate the margin of safety
Cost volume profit analysis…
Assumptions of CVP analysis
•It can only apply to a single product or a single mix of a group
of products
•Break even chart may be time consuming
•Selling price, variable cost per unit and total fixed cost remain
unaffected by increase or decrease in sales volume.
•Firm is able to sell more units without affecting the cost
structure.
•In multi product situations, product mix is known in advance
and remains constant.
•Costs can be accurately classified in to fixed and variable
categories.
Practice question
A computer software company develops and sells three
computer games, Gino, Dust and Elton. The combined sales of
all the products in 2007 was 9000 units and total fixed costs
amounted to $726 000. other relevant data for 2007 were as
follows: Gino Dust Elton
Sales price $600 $500 $450
P/V ratio 20% 30% 40%
Sales mix 5 1 4
Management expects sales in the current year to remain at
9000 total units and there is no intention to change the selling
price or cost structure. However, by reducing marketing
expenditure on Gino and spending more on Dust and Elton,
the marketing director believes that the sales mix can be
changed to 2:3:5
Required:
For the organization as a whole, calculate the P/V ratio, break even
in sales and profit of each sales mix respectively, and advice
management whether the proposed sales mix should be
implemented or not
Thanks
