University of San Jose – Recoletos

School of Business and Management | Accountancy and Finance Department

Strategic Business Analysis

Module 3: Cost-Volume-Profit and Breakeven Analysis

CVP Analysis

The study of the effects on future profit of changes in fixed cost, variable cost, sales price, quantity, and mix (CIMA)

Assumptions in CVP Analysis

• All costs are either variable or fixed costs

• Variable costing is used
• Total costs and total revenues are predictable and linear
• Total FxC, VC/u, SP/u, and Sales Mix remain constant
• Finished goods and work-in-process inventories do not change significantly
• All units produced are sold (No inventory level complications)
• Volume is the only cost driver. Inflation is ignored

Benefits of CVP Analysis

• Helps managers understand interrelationships among cost, volume, and profit

o Useful in many business decisions such as:
▪ deciding what products to manufacture or sell
▪ what pricing policy to follow
▪ what marketing strategy to employ
▪ what type of productive facilities to acquire

Doing CVP Analysis

1. The Contribution Format Income Statement

a. Income statement with behavioral cost classification
b. Must have per unit, total amount, and percentage columns
2. Charts and Graphs
a. Visual representation of CVP analysis
b. Three kinds of CVP graphs
3. Algebraic or Mathematical Formula
a. Also called as the “horizontal format”
b. Still based on the Contribution I/S

The Contribution Format Income Statement

Per Unit Total Percentage

Sales xx xxxx 100%
Variable Costs (xx) (xxxx) xx
Contribution Margin xx xxxx xx%
Fixed Costs (xx) (xxxx)
Operating Income xx xxxx

Alternative Contribution Income Statement

Sales xx
Variable Product Costs (xx)
Manufacturing or Product Margin xx
Variable Period Costs (xx)
Contribution Margin xx
Fixed Costs (xx)
Operating Income xx

The Basic Breakeven Chart

University of San Jose – Recoletos
School of Business and Management | Accountancy and Finance Department
Strategic Business Analysis

Commonly Used Formulas in CVP Analysis (Single Product)

Item Formula Concept

The total amount that contributes towards the recovery of fixed

Contribution Margin = Sales - Variable Costs
costs and the generation of profit.

The amount per unit that contributes towards the recovery of

CM per unit = SP per unit - VC per unit
fixed costs and the generation of profit.

CM The portion of the sales that contributes towards the recovery

CM Ratio =
Sales of fixed costs and the generation of profit.

CM per unit The portion of the sales that contributes towards the recovery
CM Ratio =
SP per unit of fixed costs and the generation of profit.

VC per unit
VC Ratio = The portion of sales that represent variable costs.
SP per unit

VC
VC Ratio = The portion of sales that represent variable costs.
Sales

Fixed Costs The number of units sold/produced at which there is no profit

BEP in Units =
CM per unit and no loss.

BEP in Pesos The number of units sold/produced at which there is no profit

BEP in Units =
Selling Price per Unit and no loss.

Fixed Costs
BEP in Pesos = The peso sales at which there is no profit and no loss.
CM Ratio

BEP in Pesos = BEP in Units x Selling Price per Unit The peso sales at which there is no profit and no loss.

Margin of Safety in The drop in the number of units that it will take before the
= Actual Unit Sales - BEP in Units
Units company incurs a loss.

Margin of Safety in The drop in the pesos that it will take before the company
= Actual Peso Sales - BEP in Pesos
Pesos incurs a loss.

Margin of Safety in Margin of Safety in Units x Selling Price per The drop in the pesos that it will take before the company
=
Pesos Unit incurs a loss.

Margin of Safety in Pesos The percentage drop in peso sales that it will take before the
Margin of Safety Ratio =
Actual Peso Sales company incurs a loss.

Margin of Safety in Units The percentage drop in peso sales that it will take before the
Margin of Safety Ratio =
Actual Unit Sales company incurs a loss.

Units to be Sold to Fixed Costs + Target Operating Income The number of units that must be sold/produced in order to
Achieve a Target =
generate the desired profit.
Operating Income CM per Unit

Desired Peso Sales to Fixed Costs + Target Operating Income The required peso sales that must be earned to generate the
Achieve a Target =
desired profit.
Operating Income CM Ratio

Degree of Operating Contribution Margin A measure of the sensitivity of net operating income to
=
Leverage Net Operating Income changes in sales.

Change in Fixed Cost The level of sales at which the company will be indifferent
Point of Indifference =
Change in Variable Cost between different cost structure alternatives.

BEP Pesos The portion of actual sales that pertains to the breakeven
Break-Even Ratio =
Actual Peso Sales sales.

BEP units The portion of actual unit sales that pertains to the breakeven
Break-Even Ratio =
Actual Unit Sales sales in units.

Actual Peso Sales = Break-Even Sales + MOS Pesos The sum of the breakeven sales and margin of safety.

100% = Break-Even Ratio + MOS Ratio The sum of break-even ratio and margin of safety ratio.
University of San Jose – Recoletos
School of Business and Management | Accountancy and Finance Department
Strategic Business Analysis

Multiple Breakeven Analysis

1. Using Weighted Average Contribution Margin per Unit

Product A Product B Total

Selling Price per unit P xx P xx
Variable Cost per unit (xx) (xx)
Contribution Margin per unit P xx P xx
Multiply to product margin ratio (fraction or %) * xx% * xx%
P xx P xx P xx WA CM/u

Fixed Costs
Total BEP in Units =
WA CM/u

Product A Product B
Total BEP in Units xx xx
Multiply to product margin ratio (fraction or %) * xx% * xx%
BEP in Units per product xx xx

2. Using Weighted Average Contribution Margin Ratio

Product A Product B Total

Sales 100% 100%
Variable Cost Ratio (xx%) (xx%)
Contribution Margin Ratio xx% xx%
Multiply to Sales Mix Ratio * xx% * xx%
xx% xx% xx% WA CM%

Fixed Costs
BEP in Total Pesos =
WA CM%

Product A Product B
BEP in Total Pesos P xxx,xxx P xxx,xxx
Multiply to Sales Mix Ratio * xx% * xx%
BEP in Pesos per product P xxx,xxx P xxx,xxx
University of San Jose – Recoletos
School of Business and Management | Accountancy and Finance Department
Strategic Business Analysis

Exercises

A. Breakeven Point, Margin of Safety

PM operate a bed and breakfast hotel in a resort area in the Smoky Mountains. Depreciation on the hotel is P60,000 per year. Kelly employs a maintenance
person at an annual salary of P30,000 per year and a cleaning person at an annual salary of P24,000 per year. Real estate taxes are P10,000 per year.
The rooms rent at an average price of P50 per person per night including breakfast. Other costs are laundry service at P4.00 per person per night and the
cost of food which is P6.00 per person per night.

a. Determine the number of rentals and the sales revenue Kelly needs to break even using the contribution margin technique.
b. If the current level of rentals is 4,000, by what percentage can rentals decrease before Kelly has to worry about having a net loss?
c. Kelly is considering upgrading the breakfast service to attract more business and increase prices. This will cost an additional P5.00
for food costs per person per night. Kelly feels she can increase the room rate to P65 per person per night. Determine the number of
rentals and the sales revenue Kelly needs to break even if the changes are made.

B. Required Sales considering Desired Profit

Grange Company had a net loss of P100,000 in 2001 when the selling price per unit was P20, the variable costs per unit were P12, and the fixed costs
were P400,000. Management expects per unit data and total fixed costs to be the same in 2002. Management has set a goal of earning net income of
P100,000 in 2002.

a. Compute the units sold in 2001.

b. Compute the number of units that would have to be sold in 2002 to reach management’s desired net income level.
c. Assume that Grange Company sells the same number of units in 2002 as they did in 2001. What should the selling price have to be in order to
reach the target net income?

C. Breakeven Point, Required Sales considering Desired Profit

Rush Company developed the following information for its product:

Per Unit
Sales price P90
Variable cost 63
Contribution margin P27
Total fixed costs P1,350,000

1. How many units must be sold to break even?

2. What is the total sales that must be generated for the company to earn a profit of P60,000?
3. If the company is presently selling 75,000 units, but plans to spend an additional P135,000 on an advertising program, how many additional
units must the company sell to earn the same net income it is now making?
4. Using the original data in the problem, compute a new break-even point in units if the unit sales price is increased 20%, unit variable cost is
increased by 10%, and the total fixed costs are increased by P198,000

D. Breakeven Point – Multiple Products

PM Corporation produces three products, P, W, and M, with the following related data:
P W M
Unit sales price P200 P50 P120
Unit variable costs 120 20 90
Sales mix in units 2 5 3
Total fixed costs, P800,000

1. Determine the weighted average unit contribution margin.

2. Determine the composite BEP in units and allocation of composite BEP.
3. How much is the composite BEP in pesos?
4. How much is the number of units to be sold if the firm wants a profit of P40,000?

E. Operating Leverage

PM discloses the following data relative to its product MP for its 2016 operations:

Contribution margin (40,000 units x P50) 2,000,000

Total fixed costs and expenses 1,200,000
CMR Ratio 40%

1. What is the DOL?

2. What would be the percentage increase in profit before tax if sales are expected to increase by 40% in 2017?
3. If the firm wants to increase its DOL to 4.0 in 2017, how much should be the needed increased in fixed costs assuming the contribution margin
remains the same?

F. Indifference Point

PM has decided to introduce a new product. The new product can be manufactured by wither a fully automated process or a semi-automated process.
The manufacturing process will not affect the quality of the product. The estimated unit manufacturing costs by the two methods follow:

Fully-automated Semi-automated
Materials 5 6
Direct labor 6 7
Variable Fixed Overhead 3 4

Directly traceable incremental fixed overhead is expected to be P2,380,000 if the fully-automated process is chosen and P1,285,000 if the semi-automated
process is chosen. The company’s Market Research Department has recommended an introductory unit sales price of P40. Regardless of the
manufacturing process chosen, the incremental marketing expenses are estimated to be P500,00 per year plus P2 per each unit sold.

1. Calculate the estimated breakeven point for the new product in annual units of sales if the company uses the:
a. Fully-automated manufacturing process
b. Semi-automated manufacturing process
2. Determine the annual unit sales volume at which the choice between the two manufacturing processes would not make a difference