CHAPTER-9

COST-VOLUME-PROFIT
ANALYSIS (CVP)
COST-VOLUME-PROFIT ANALYSIS
 Cost volume profit analysis is a
systematic method of examining
the relationship between selling
price, total sales revenue, volume of
production, expenses and profit.
 Fixed Cost Per Unit
Fixed costs per unit decline
as activity increases.

Your average cost per

unit decreases as
Total fixed cost
more units are used.
Number of units
 Variable Cost Per Unit

 Variable costs per unit do not change

as activity increases.

Charge
Per unit
The cost per unit is constant.
 Cost Behavior Summary
Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit

Changes as activity level Remains the same over wide

Variable
changes. ranges of activity.
Remains the same even Dereases as activity level
Fixed
when activity level changes. increases.
  Mixed Costs

 Mixed costs contain a fixed portion that is incurred

even when facility is unused, and a variable
portion that increases with usage.
Example: monthly electric utility charge
 Fixed service fee

 Variable charge per

kilowatt used
Mixed Costs
Slope is
variable cost
per unit
of activity.
Total Utility Cost

ost
dc Variable
i xe
l m
ta Utility Charge
To

Fixed Monthly
Utility Charge
Activity (Kilowatt Hours)
1. Contribution Margin Concept
• Contribution margin concept indicates the profit
potential of a business enterprise and also highlights
the relationship between cost, sales and profit.
• Contribution margin is the excess of sales revenue over
variables costs
(under contribution concept variable cost includes all variable
production and selling costs)
Formula to calculate contribution margin ratio is

sales  var iable cos t

sales
Example:
 Assume the following information in case a
company
sales $100,000
Variable costs 60,000
Fixed costs 30,000
A. How much is the contribution margin?
Contribution margin = sales – variable costs
= 100,000 – 60,000
= 40,000
Profit = contribution margin – Fixed cost
= 40,000 – 30,000
= 10,000
 B. Contribution margin ratio

Contribution margin ratio =

sales  var iable cos t
sales

100,000  60,000
100,000

= 40%
 P/v ratio( contribution margin ratio) helps to know the
effect of a firm due to an increase or decrease in
volume of sales.
 For example, taking the previous example and if the
enterprise has an interest to increase its sales by
$40,000, what will be the profit?
Sales (100, 000 + 40,000) $140,000
Less: Variable cost (140, 000 x 60%) 84,000
Contribution margin (140, 000 x 40%) 56,000
Less: Fixed cost 30,000
Profit 26,000
2.Computing Break-Even Point
1.
 Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How
Howmuch
muchcontribution
contributionmargin
marginmust
mustthis
thiscompany
companyhave
haveto
to
cover
coverits
itsfixed
fixedcosts
costs(break
(breakeven)?
even)?
 Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How
Howmuch
muchcontribution
contributionmargin
marginmust
mustthis
thiscompany
companyhave
haveto
to
cover
coverits
itsfixed
fixedcosts
costs(break
(breakeven)?
even)?
Answer:
Answer: $30,000
$30,000
 Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How
Howmany
manyunits
unitsmust
mustthis
thiscompany
companysell
sellto
tocover
coverits
itsfixed
fixedcosts
costs
(break
(breakeven)?
even)?
 Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How
Howmany
manyunits
unitsmust
mustthis
thiscompany
companysell
sellto
tocover
coverits
itsfixed
fixedcosts
costs
(break
(breakeven)?
even)?
Answer:
Answer: $30,000
$30,000÷÷$20
$20per
perunit
unit==1,500
1,500units
units
 2. CONTRIBUTION MARGIN METHOD

We have just seen one of the basic CVP relationships – the

break-even computation.

Fixed costs
Break-even point in units =
Contribution margin per unit

Unit sales price less unit variable cost

($20 in previous example)
 Computing Break-Even Sales
Question 1
ABC
ABCCo.
Co.sells
sellsproduct
productXYZ
XYZatat$5.00
$5.00per
perunit.
unit. IfIffixed
fixedcosts
costsare
are
$200,000
$200,000and
andvariable
variablecosts
costsare
are$3.00
$3.00per
perunit,
unit,how howmany
manyunits
units
must
mustbebesold
soldtotobreak
breakeven?
even?

a.
a. 100,000
100,000units
units ANS:
ANS:
b.
b. 40,000
40,000units
units Unit contribution = $5.00 - $3.00 = $2.00
c.c. 200,000
200,000units
units Fixed costs = $200,000
d.
d. 66,667
66,667units
units Unit contribution $2.00 per unit
 Computing
Computing Break-Even
Break-Even Sales
Sales
Question-2
Question-2
Use
Use the
the contribution
contribution margin
margin ratio
ratio formula
formula toto determine
determine the
the
amount
amount of of sales
sales revenue
revenue ABC
ABC must
must have
have to
to break
break even.
even. All
All
information
information remains
remains unchanged:
unchanged: fixed
fixed costs
costs are
are $200,000;
$200,000; unit
unit
sales
sales price
price isis $5.00;
$5.00; and
and unit
unit variable
variable cost
cost isis $3.00.
$3.00.

a.
a. $200,000
$200,000
Unit contribution = $5.00 - $3.00 = $2.00
b.
b. $300,000
$300,000
Contribution margin ratio = $2.00 ÷ $5.00 = .40
c.c. $400,000
$400,000 Break-even revenue = $200,000 ÷ .4 =$500,000
d.
d. $500,000
$500,000
Preparing a CVP Graph

 Draw the total cost line with a slope

equal to the unit variable cost. Revenue

Costs and Revenue

Break-even
Profit
Point
in Dollars

Total cost

Loss
Total fixed cost

Volume in Units
Computing Sales Needed to Achieve Target
Operating Income
Break-even
Break-even formulas
formulas may
may be
be adjusted
adjusted toto show
show
the
the sales
sales volume
volume needed
needed to to earn
earn
any
any amount
amount of
of operating
operating income.
income.

Fixed costs + Target income

Unit sales =
Contribution margin per unit

Fixed costs + Target income

Dollar sales =
Contribution margin ratio
Computing Sales Needed to Achieve
Target Operating Income
ABC
ABC Co.
Co. sells
sells product
product XYZ
XYZ at
at $5.00
$5.00 per
per unit.
unit. IfIf
fixed
fixed costs
costs are
are $200,000
$200,000 and
and variable
variable costs
costs
are
are $3.00
$3.00 per
per unit,
unit, how
how many
many units
units must
must bebe
sold
sold to
to earn
earn operating
operating income
income ofof $40,000?
$40,000?

a.
a. 100,000
100,000 units
units Unit contribution = $5.00 - $3.00 = $2.00
b.
b. 120,000
120,000 units
units Fixed costs + Target income
Unit contribution
c.
c. 80,000
80,000 units
units
$200,000 + $40,000
d.
d. 200,000
200,000 units
units $2.00 per unit = 120,000 units
 What is our Margin of Safety?
Margin of safety is the amount by which sales may decline
before reaching break-even sales:
Margin of safety = Actual sales/Expected - Break-even
sales

Margin of safety provides a quick means of

estimating operating income at any level of
sales:

Operating Margin Contribution

Income = of safety × margin ratio
 What is our Margin of Safety?
ABC’s contribution margin ratio is 40 percent. If
sales are $100,000 and break-even sales are
$80,000, what is operating income?

Operating Margin Contribution

Income = of safety × margin ratio

Operating
Income = $20,000 × .40 = $8,000
What Change in Operating Income Do We
Anticipate?
Once break-even is reached, every additional dollar of
contribution margin becomes operating income:

Change in Change in Contribution

operating income = sales volume × margin ratio
ABC expects sales to increase by $15,000. How much will
operating income increase?

Change in
operating income = $15,000 × .40 = $6,000
 Business Applications of CVP

Consider the following information developed by

the accountant at Cycle Co, a bicycle retailer:

Total Per Unit Percent

Sales (500 bikes) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
Operating income $ 20,000
 Business Applications of CVP

Consider the following information developed by

the accountant at Cycle Co, a bicycle retailer:

Total Per Unit Percent

Sales (500 bikes) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
Operating income $ 20,000
 Business Applications of CVP

Should CyclCo spend $12,000 on advertising to

increase sales by 10 percent?

Total Per Unit Percent

Sales (500 bikes) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
Operating income $ 20,000
 Business Applications of CVP

Should Cycle Co spend $12,000 on advertising

to increase sales by 10 percent?
500 550
Bikes 550 × $500 Bikes
Sales $ 250,000 $ 275,000
Less: variable expenses 150,000 165,000
550 × $300
Contribution margin $ 100,000 $ 110,000
Less: fixed expenses 80,000 92,000
Operating income $ 20,000 $80000 + $12000$ 18,000

No, income is decreased.

 Business Applications of CVP
Now, in combination with the advertising,
Cycle Co is considering a 10 percent price reduction that will
increase sales by 25 percent. What is the income effect?
500
Bikes
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin $ 100,000
Less: fixed expenses 80,000
Operating income $ 20,000
 Business Applications of CVP
Now, in combination with the advertising,
CyclCo is considering a 10 percent price reduction that will
increase sales by 25 percent. What is the income effect?
500 1.25 × 500 625
Bikes Bikes
Sales $ 250,000 625 × $450 $ 281,250
Less: variable expenses 150,000 187,500
Contribution margin $ 100,000 625 × $300 $ 93,750
Less: fixed expenses 80,000 92,000
Operating income $ 20,000 $80000 + $12000 $ 1,750

Income is decreased even more.

 Business Applications of CVP
Now, in combination with advertising and a price cut, Cycle Co
will replace $50,000 in sales salaries with a $25 per bike
commission, increasing sales by 50 percent above the
original 500 bikes. What is the effect on income?
500
Bikes
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin $ 100,000
Less: fixed expenses 80,000
Operating income $ 20,000
 Business Applications of CVP
Now, in combination with advertising and a price cut, Cycle Co
will replace $50,000 in sales salaries with a $25 per bike
commission, increasing sales by 50 percent above the
original 500 bikes. What is the effect on income?
500 750
1.5 × 500
Bikes Bikes
Sales $ 250,000 750 × $450 $ 337,500
Less: variable expenses 150,000 243,750
Contribution margin $ 100,000 750 × $325 $ 93,750
Less: fixed expenses 80,000 42,000
Operating income $ 20,000 $92000 - $50000 $ 51,750

The combination of advertising, a price cut,

and change in compensation increases income.
CVP Analysis When a Company Sells Many
Products
Sales
Sales mix mix isis the
the relative
relative combination
combination in in which
which
aa company’s
company’s different
different products
products areare sold.
sold.
ItIt refers
refers to
to the
the ratio
ratio or
or relative
relative combination
combination ofof
each
each product’s
product’s sales
sales to
to total
total sales.
sales.
Different
Different products
products havehave different
different selling
selling prices,
prices,
costs,
costs, andand contribution
contribution margins.
margins.
 Sales mix is the composition of total sales broken
down among various products or product lines.
 Example: A company has three products labeled as
Model X, Model Y and Model Z. Sales on monthly
basis are expected to be as follows:
Model X Model Y Model Z Total
Unit 1,000 1,500 2,500 5,000
Sales ratio 20% 30% 50% 100%
 This means that for every 2 units of model x that are sold,
there are 3 units of model y and 5 units of model z. Or
 Multi products would have 2 units model x, 3 units model y
and 5 units model z, for a total of 10 units
Example:
 A company has three sales ratio of 2:3:5 for model x,
model y and model z. Total fixed costs for the month are
$200,000. The sales price, variable costs and
contribution margin associated with each product are as
follows:

Model X Model Y Model Z

Sales prices $50 $25 $10
 Variable costs 30 15 8
 Contribution margin 20 10 2

How much is the total contribution margin of the average market basket
(consists of 10 units) based on the sales ratio?
Solution:

 The total contribution of the average market

basket is based on the sales ratio and
consists of 10 units
 = (2 x $20) + (3 x $10) + (5 x $2)
 = $80
How much is the break even point in the market
basket?
 The break even point in the market basket is
computed using the break even point formula:-
$200000

$80
 2500units
In order to fill 2,500 baskets, it will take the following amounts for each model:
Model x 500 units which is 2,500 units X 2/10
Model y 750 units 2,500 units X 3/10
Model z 1250 units 2,500 units X 5/10
This is the break even point for each model as long as the sales mix stays at
2:3:5
How much is the Break even point3 in
x $25 = $75
sales? 3 x $15 = $45
5 x $10 = $50
 Calculate the contribution margin ratio 5 x $8 = $40
Solution:
Model X Model Y Model Z Total

Sales price 2 x $50 = $100 $100 $75 $50 $225

Variable cost 2 x $30 = $60 $60 $45 $40 $145
Contribution Margin $40 $30 $10 $80

Contribution margin ratio = ($80 ÷ 225) x 100

= 35.555%
Then, Break even point in sales = ($200,000 ÷ 35.555%)
= $562,500
Example 2

Cycle Co provides us with the following

information:
Bikes Carts Total
Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Net income $ 95,000
Compute contribution margin:

The overall contribution margin ratio is:

Bikes Carts Total

Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Net income $ 95,000

$265,000
= 48% (rounded)
$550,000
Compute Break even point in Dollar value.

Break-even in sales dollars is:

Bikes Carts Total

Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Operating income $ 95,000

$170,000
= $354,167 (rounded)
.48