Cost Volume Profit Analysis

Cost-Volume Profit Analysis (CVP Analysis) is a powerful tool for planning and decision making. It
emphasizes the interrelationships of costs, quantity sold, and price.

The end goal of CVP Analysis is to figure out the break-even point (BEP), or the number of units sold
where the company recovers the costs of production. Additional units sold above the break-even point
result in profits, while units sold below the BEP amount to losses.

Important concepts in CVP Analysis are the following:

 Fixed costs. These costs stay the same within a range of production, regardless of the number of
units produced or sold. This is because although fixed costs are necessary for production, they
exist independently. A simple example of a fixed cost is rent paid on buildings: the rent paid does
not increase or decrease the more or less units are produced.
 Variable costs. These are costs incurred for each unit produced.
 Semi-variable costs. These costs are a mix of fixed and variable costs.
 Contribution margin. The difference between revenue and variable costs.

Solving for the BEP requires an understanding of the costs above. Further, the relationship between costs
and quantity of units can be summarized as follows:

Fixed Cost Variable Cost

Total Cost Stays the same Increases for more units
Per unit cost Decreases for more units Stays the same

CVP Analysis makes an extensive use of the following formula:

Revenue – Variable Costs – Fixed Costs = Profit

Revenue = Selling price x Quantity sold

Variable costs = Variable cost per unit x Quantity sold
Under break-even, profit is 0.

The equation can be rewritten as follows:

(Selling price x Qty) – (Var. Cost x Qty) – Fixed Costs = Profit

or [(Selling price – Var. Cost) x Qty] – Fixed Costs = Profit

Note that (Selling Price – Var. Cost) is the same as the Contribution Margin.

Illustrations are as follows:

ABC Corp incurred a total of ₱250,000 in variable costs and ₱500,000 in fixed costs. How many units must
the company sell to break-even if it sells each unit at ₱10?
 (Selling price x Qty) – Variable Costs – Fixed Costs = Profit
10(Qty) – 250,000 – 500,000 = 0
10Qty = 750,000
Qty = 75,000

ABC Corp has the following data:

Selling Price ₱20

Variable cost per unit 12
Fixed expenses 64,000

Computing the BEP:

[(Selling price – Var. Cost) x Qty] – Fixed Costs = Profit

The selling price must be
above the variable cost,
otherwise the company can
never recover all the costs, as
each unit produced already
incurs a variable cost. In
other words, the variable
cost is part of the price.
Computing semi-variable costs
[₱20 – ₱12][Qty] – ₱64,000 = 0
8Qty = 64,000
Qty = 8,000 units
Essentially, what the company recovers
is the fixed cost, as the variable cost
must already be covered by the selling
price.
In other words, the excess of the selling
price over the variable cost will be used
to cover the fixed cost. Once the fixed
cost is covered, the excess is profit.

As seen above, the fixed cost is recovered through sales of units. Each unit sold should already cover the
variable cost incurred. As a result, a proper analysis requires separating the variable cost and the fixed
cost. Semi-variable costs are a mix of fixed and variable costs, and a result its fixed component must be
separated.

There are many ways to separate semi-variable costs into its fixed and variable components. In a real
situation, these methods are estimates at best and can never fully separate the semi-variable costs. One
of the simplest and more common methods is using the high-low method.

An illustration is as follows:

ABC Corp pays ₱300,000 in electricity bills when producing 100,000 units. When producing 150,000 units,
the electricity costs increase to ₱325,000. Separate the fixed and variable portion using high-low method.

[Change in Cost] / [Change in Quantity] = Variable portion

[325,000 – 300,000] / [150,000 – 100,000]
25,000 / 50,000
Variable portion = ₱0.5 per unit

In semi-variable costs, the fixed cost portion is the minimum cost that occurs at zero production. Thus,
the increase in the total semi-variable costs is the variable cost portion. Accordingly, the computation
above shows the change in cost as a result of the change in units. This lets you calculate the variable
portion.
 Total semi-variable cost = Fixed Cost portion + variable cost portion
Using either amount
₱300,000 = FC + (100,000 x 0.5)
should yield the same 300,000 = FC + 50,000
result. FC = ₱250,000

Once the fixed portion and the variable portion are separated, they can be used to compute the BEP.

Multiple product analysis

The illustrations above focus on only one product of the business. However, in the real world, each
company produces more than one product side by side. One way to perform CVP analysis is to treat these
products separately and analyze them one by one. However, sometimes multiple product lines share costs
with each other. For example, the creation of a regular brand and a premium brand product may be made
in the same warehouse. In that case, expenses such as the rent on the warehouse cannot be easily
allocated to the products.

One way to perform CVP analysis is by using the sales mix method. Essentially, all the products are treated
as a single package to be sold, with each package containing a fixed mix of products.

For example, Eevee BV sells plastic toys in two variants: the standard red color, and the premium Master
purple. Details for each variant is as follows:

Standard Premium
Units sold 30,000 10,000
Variable Costs ₱150,000 ₱160,000
Fixed Costs specific to the product 200,000 150,000
Rent on the shared warehouse 50,000
Selling price ₱10 ₱30

In order to solve the problem, we get the relative sales mix, which is the proportion of units expected to
be sold:

30,000 standard: 10,000 premium

3:1

From here, we can solve the problem as follows:

Standard Premium
Variable Costs ₱150,000 ₱160,000
Units 30,000 10,000
Per unit variable cost ₱5 ₱16

Obtain the contribution margin per unit for each item, and multiply that by the number of units in the
sales mix. Afterwards, add the products:
 Selling price minus variable cost for premium

[3 x (₱10 – 5)] + [1 x (₱30 – 16)]Qty – [200,000 + 150,000 + 50,000] = 0

[(3 x 5) + (1 x 14)]Qty = 400,000
29Qty = 400,000
Selling price minus Qty = 13,793.10345… sets Fixed Costs
variable cost for standard Standard: 13,793.10345 x 3 = 41,380 units
Premium: 13,793.10345 x 1 = 13,794 units

The actual result would have fractional units. However, because in the real world you cannot sell a
fraction of a unit, you must round it upward (rounding down would result in a net loss).