LESSON 1-4

COST -VOLUME-PROFIT ANALYSIS

INTRODUCTION

Cost-Volume-Profit (CVP) Analysis is used to determine how changes in costs, sales volume and price
affect the company’s profit. In performing the CVP analysis there are several assumptions made, including:

• Sales price, variable cost and fixed costs are constant.

• The company is operating within the relevant range of activity. Relevant range refers to the range
of activity where variable cost per unit and total fixed costs is constant.
• Everything produced is sold.
• Costs are only affected by the changes in activity.
• If the company sells more than one product, they must be sold in the same mix.

CVP Analysis is used to determine the break-even point (BEP), which is the point of zero profit. In BEP the
company has no profit nor loss, this point is where the total revenue is equal to total costs.

Several questions can be answered by CVP Analysis including:

• How many numbers of units are to be sold to break-even?

• What is the effect of changes in the fixed costs on the BEP?
• What is the effect of changes in sales price on the BEP?

CVP analysis requires that costs be classified according to their tendency to vary with production (mixed,
variable, and fixed costs) rather than their functional classification (manufacturing, selling and
administrative). Mixed costs shall be segregated to their variable and fixed components using any of the
three methods: high-low point, scatter graph and least square method.

Contribution margin and contribution margin ratio

Contribution margin per unit (CMu) is the remaining amount after deducting variable cost per unit from the
selling price per unit.

CMu = Selling Price per unit – Variable Cost per unit

Contribution margin ratio (CMR) is the percentage contributed by each unit to the recovery of the fixed
costs.

CMR = CMu ÷ Sales price per unit

Break-even point

As stated, break-even point (BEP) is the point where the company has no loss nor profit. In other words,
sales are equal to costs or contribution margin equals fixed costs.

To compute the BEP in units (BEPu), the formula is:

Total fixed costs

BEPu =
Sales price – Variable costs per unit
 OR

Total fixed costs

BEPu =
Contribution margin per unit

To compute the BEP in pesos (BEP₱), the formula is:

Total fixed costs

BEP₱ =
Contribution margin ratio

OR

BEP₱ = BEPu x Variable costs per unit + Total fixed costs

OR

BEP₱ = BEPu x Selling price per unit

Illustrative Problem 1

Cat Company produces a product that sells for ₱800.00. The variable costs is ₱360 for direct materials and
₱200 for labor, ₱50 for variable overhead and ₱30,000 for fixed overhead. The units sold for the month is
500 units.

Required:

1. Compute for the total variable costs per unit.

2. Compute for the total fixed costs.
3. Compute for the BEP (units).
4. Compute for the contribution margin.
5. Compute for the contribution margin ratio.
6. Compute for the BEP (pesos).

Solution:

1 Direct materials 350

Direct labor 200
Variable overhead 50
Total variable
costs 600

2 Total fixed costs 30,000

3 BEP (units) = Total fixed costs

Selling Price per unit − variable costs per unit

= ₱30,000
₱800−₱600

= 150 units
 4 Contribution margin per unit = Selling price − variable costs

= ₱800 − ₱600

= ₱200 / unit

5 Contribution margin ratio = Contribution margin per unit

Selling price per unit

= ₱200
₱800

= 25%

6 BEP (pesos) = Total fixed costs

CM ratio

= ₱30,000
25%

= ₱120,000

OR

BEP (pesos) = 150 units x ₱800

= ₱120,000

If a statement is prepared for the breakeven sales, it will appear as:

Sales ₱ 120,000
Variable costs 90,000
Contribution margin 30,000
Fixed costs 30,000
Net income ₱ −

The contribution margin statement of Cat Company assuming sales of 500 units will appear as:

Sales (500 x 800) ₱ 400,000

Variable costs (500 x 600) 300,000
Contribution margin 100,000
Fixed costs 30,000
Net income ₱ 70,000

If we express the contribution margin statement as a formula:

Net income = revenue – total variable costs – total fixed costs

CVP analysis allows managers to do sensitivity analysis by examining the effect of various price or cost
levels on profit. CVP analysis shows how revenues, expenses, and profits behave as volume changes.

The Cost Volume Profit Graph

Using Illustrative Problem 1

Sales
Price Variable Fixed Total Profit
Quantity /unit Sales Costs Costs Costs (Loss)
50 800 40,000 30,000 30,000 60,000 (20,000)
100 800 80,000 60,000 30,000 90,000 (10,000)
150 800 120,000 90,000 30,000 120,000 −
200 800 160,000 120,000 30,000 150,000 10,000
250 800 200,000 150,000 30,000 180,000 20,000
300 800 240,000 180,000 30,000 210,000 30,000
350 800 280,000 210,000 30,000 240,000 40,000

Graph 1: Revenue and Costs

Revenue and Costs

180,000

160,000

140,000

120,000

100,000

80,000

60,000

40,000

20,000

-
50 100 150 200 250 300 350

Sales Variable Costs Fixed Costs Total Costs

Based on Graph 1, the point where the Sales and Total Costs intersect is the break-even point -- ₱120,000
and 150 units.
Graph 2: Profit Volume Graph

Profit Volume Graph

50000

40000

30000

20000 PROFIT

10000 BEP
150 Units
0
50 100 150 200 250 300 350
-10000

-20000

-30000

Based on Graph 2, the point where the company has no profit nor loss is at the break-even point (150
units).

Margin of Safety

Margin of Safety is the units sold or revenue earned beyond the BEP volume. In other words, it represents
the number of units or amount of sales revenue that the company can absorb before incurring a loss. For
example, if the current sales is 500 units and the BEP is 150 units the margin of safety is 359, units. The
formula to compute the margin of safety is:

Margin of safety = Current Sales – BEP Sales

Margin of safety in pesos = Margin of Safety in units x Sales Price per unit

Margin of safety ratio = Margin of safety ÷ Total sales

In the event that sales take a downward turn, the risk of suffering a loss is lesser if the as the margin of
safety increases. If the margin of safety is small, managers must take actions to increase sales or decrease
cost.

CVP Analysis in Multiproduct

CVP analysis is easy to use if the company is producing and selling a single product however, in many
instances, businesses produce and sell more than one product. If there are two or more products, we simply
convert the multi-product problem to a single product problem to compute the break-even point. The key to
this conversion is to know the expected sales mix. Sales mix is the standard relationship of the products
sold in a given period of time. In the multi-product sales analysis, the sales mix ratio is assumed to be
constant.
In computing for the break-even point of a single product we divide the total fixed costs by the contribution
margin, in multi-product we will change the denominator to average contribution margin. The formula to
compute for the average contribution margin is ∑ (unit CM x sales mix ratio). To fully understand the
formulas, a sample illustrative problem is given.

Illustrative Problem 2

Luntian Corporation produces and sells three product and has provided the following data:

Products
Total
X Y Z
Unit sales price 400 600 700
Unit variable costs 100 350 500
Budgeted sales in units 500 300 200 1,000
Budgeted sales in pesos 180,000 200,000 140,000 520,000
Total fixed cost 795,000

Assume that the sales mix will be the same at all sales levels.

Compute for the following:

1. Average contribution margin

2. Break-even point in total units
3. Units X, Y and Z must sell at break-even point.
4. Total contribution margin if the company expects profit of ₱2,000,000.

Solution:

Sales Mix Average

1 Product Unit CM Ratio UCM
(units)* (UCM x SMR)
X 300 0.50 150
Y 250 0.30 75
Z 200 0.20 40
Ave. Unit CM 265
* budgeted sales in units per product ÷ total budgeted sales in units

Sales Mix Average

Product CM Ratio UCM
Ratio (pesos)* (UCM x SMR)
X 75.00% 0.38 28.8462%
Y 41.67% 0.35 14.4231%
Z 28.57% 0.27 7.6923%
Ave. CM Ratio 50.9615%
* budgeted sales in pesos per product ÷ total budgeted sales in pesos
2 BEP (units) = Total fixed costs
Average Unit CM

= 795,000
265

= 3,000 units

BEP (pesos) = Total fixed costs

Average CM Ratio

= 795,000
50.9615%

= ₱ 1,560,000

3 Product Unit CM Sales Mix Allocated

Ratio BEP
(units)* (units)*
X 3,000 0.50 1,500
Y 3,000 0.30 900
Z 3,000 0.20 600
* unit CM x sales mix ratio (units)

Checking:
Sales
X (1500 x 400) 600,000
Y (900 x 600) 540,000
Z (600 x 700) 420,000 1,560,000

Variable costs
X (1500 x 100) 150,000
Y (900 x 350) 315,000
Z (600 x 500) 300,000 765,000
Contribution margin 795,000
Less: Total fixed cost 795,000
Net income (loss) −

4 Expected net income 2,000,000

Total fixed cost 795,000
Total contribution margin 2,795,000
Sales and Units with Desired Profit

Companies main objective is to generate profit. Managers use CVP analysis to determine how many units
must be sold, or how much sales revenue must be realized to earn a desired net income. The formula will
be simply adding desired profit to the fixed cost divided by the contribution margin per unit which do not
differ much from the BEP formula.

Desired Profit + Total fixed costs

Sales =
Contribution margin per unit

Illustrative Problem 3

Lila Company provided the following information for the month of August.

Sales ₱ 550,000
Total fixed cost 140,000
Selling price per unit 20
Variable cost per unit 12

Compute the following:

1. Sales (units and amount) to break even

2. Sales if the company desires a profit of P120,000

Solution:

1 BEP (units) = Total fixed costs

CM per unit

= 140,000
8

= 17,500 units

BEP (pesos) = BEP (units) x Selling price per unit

= 17,500 x 20

= 350,000

OR

BEP (pesos)= Total fixed costs

CM Ratio

= 140,000
40%

= 350,000
 2 Sales with profit= Fixed Cost + Desired Profit
Contribution Margin Ratio

= 140,000+120,000
40%

= 650,000

Checking:

Sales 650,000
Variable cost (650,000x60%) 390,000
Contribution margin 260,000
Fixed cost 140,000
Net income 120,000

Illustrative Problem 4

Bughaw Company determines its sales price and costs structure as follows:

Unit sales price 400

Unit variable costs 240
Total fixed costs 800,000

How much is the sales if profit is expressed as:

1. Profit before tax of ₱400,000.

2. Profit after tax of ₱480,000, tax rate is 40%.
3. Profit is 20% of sales, before tax.
4. Profit is ₱25 per unit, before tax.
5. Profit is 20% of sales, after tax of 40%
6. Profit is 20% of contribution margin, before tax.
7. Profit is 20% of contribution margin, after tax of 40%.
Solution:

Explanation of Profit Formula Application Checking

1 Proft before tax Sales (units) = FC + PBT Sales (units) = 800,000 + 400,000 Sales 3,000,000
UCM 160 Variable Cost 1,800,000
Contribution Margin 1,200,000
= 7,500 units Fixed Cost 800,000
Net Income before tax 400,000
Sales (pesos) = FC + PBT Sales (pesos) = 800,000 + 400,000
CMR 40%

= ₱ 3,000,000

2 Profit after tax Sales (units) = FC + (PAT / 1-tax rate) Sales (units) = 800,000 + (480,000/.6) Sales 4,000,000
UCM 160 Variable Cost 2,400,000
Contribution Margin 1,600,000
= 10,000 units Fixed Cost 800,000
Net Income before tax 800,000
Sales (pesos) = FC + (PAT / 1-tax rate) Sales (pesos) = 800,000 + (480,000/.6) Tax 320,000
CMR 40% Net Income after tax 480,000

= ₱ 4,000,000

3 Profit % before tax Sales (pesos) = FC Sales (pesos) = 800,000 Sales 4,000,000
CMR - PRBT 40% - 20% Variable Cost 2,400,000
Contribution Margin 1,600,000
= ₱ 4,000,000 Fixed Cost 800,000
Net Income before tax 800,000

Sales 4,000,000
Profit as % of Sales 20%
Net income before tax 800,000

Profit per unit before

4 tax Sales (units) = FC Sales (units) = 800,000 Sales 2,370,400
Explanation of Profit Formula Application Checking

UCM - UPM 160 - 25 Variable Cost 1,422,240

Contribution Margin 948,160
= 5,926 units Fixed Cost 800,000
Net Income before tax 148,160
÷ # of units sold 5,926
Profit per unit before tax 25

5 Profit % after tax Sales (pesos) = FC Sales (pesos) = 800,000 Sales 12,000,000
CMR - (PRBT / ATR) 40% - (20% / 60%) Variable Cost 7,200,000
Contribution Margin 4,800,000
= ₱ 12,000,000 Fixed Cost 800,000
Net Income before tax 4,000,000
Tax 1,600,000
Net Income after tax 2,400,000

Sales 12,000,000
Profit as % of Sales 20%
Net income after tax 2,400,000

6 Profit % based on Sales (pesos) = FC Sales (pesos) = 800,000 Sales 2,500,000

CM, before tax CMR - PR 40% - (1 - 20%) Variable Cost 1,500,000
Contribution Margin 1,000,000
= ₱ 2,500,000 Fixed Cost 800,000
Net Income before tax 200,000

Contribution Margin 1,000,000

Profit as % of CM 20%
Net income before tax 200,000

7 Profit % based on Sales (pesos) = FC Sales (pesos) = 800,000 Sales 3,000,000

CM, after tax CMR - [1 - (PRBT/ATR)] 40% - [1 - (20% / 60%)] Variable Cost 1,800,000
Contribution Margin 1,200,000
Explanation of Profit Formula Application Checking

= ₱ 3,000,000 Fixed Cost 800,000

Net Income before tax 400,000
Tax 160,000
Net Income after tax 240,000

Contribution Margin 1,200,000

Profit as % of CM 20%
Net income before tax 240,000

UPM = Unit Profit

CMR = Contribution Margin Ratio PR = Profit Rate Margin
FC = Fixed Costs PRBT = Profit Rate Before Tax PPAT = Profit Percentage after Tax
PBT = Profit Before
Tax UCM = Unit Contribution Margin ATR = 1 - Tax rate
PAT = Profit After Tax
CVP Sensitivity Analysis

The assumptions that sales price, unit variable costs, and total fixed costs are constant are made to
establish ballpark figures. These figures serve as initial points of understanding the result of business
operations. These assumptions are not reflective of practical business conditions as changes are inevitable
in the real world.

The process of considering the impact of changes of sales price, variable costs, fixed costs and sales mix
in profit and related information is called as CVP Sensitivity Analysis. This analysis concerns about
predicting the outcome of profit given the relative changes. The analysis may also determine the effect of
the changes to contribution margin, margin of safety and break-even point.

Illustrative Problem 5

Kahel Enterprises produces and sells products. The following data are available:

Unit sales price 80

Unit variable
costs 50
Total fixed costs 600,000
Units sold 45,000

What would the CMR, BEP (pesos), Operating income and Margin of safety be if:

Case A: Unit sales price increases by 20%.

Case B: Unit variable costs increases by 10%.
Case C: Total fixed costs decrease to 450,000
Case D: Units sold increase by 20%.

Answers:

Operating
CMR BEP (pesos) Margin of Safety
Income
Given 37.50% 1,600,000 750,000 2,000,000
Case A 47.92% 1,252,174 1,470,000 3,067,826
Case B 31.25% 1,920,000 525,000 1,680,000
Case C 37.50% 1,200,000 900,000 2,400,000
Case D 37.50% 1,600,000 1,020,000 2,720,000