CVP Analysis

Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume
affect a company's operating income and net income. In performing this analysis, there are
several assumptions made, including:

 Sales price per unit is constant.

 Variable costs per unit are constant.
 Total fixed costs are constant.
 Everything produced is sold.
 Costs are only affected because activity changes.
 If a company sells more than one product, they are sold in the same mix.
CVP analysis requires that all the company's costs, including manufacturing,
selling, and administrative costs, be identified as variable or fixed.
Contribution margin and contribution margin ratio
Key calculations when using CVP analysis are the contribution margin and
the contribution margin ratio. The contribution margin represents the
amount of income or profit the company made before deducting its fixed
costs.
 Contribution
 Profit Volume Ratio (P/V Ratio or Contribution/Sales (C/S))
 Break-Even Point
 Margin of Safety

Cost volume Profit Analysis

 Profit = Sales revenue – Variable costs – Fixed costs 

where the sales revenue at break-even point = Fixed cost + Variable cost

This equation can be restated as follows:

Profit = (Unit sales price x Sales volume in units) – (Unit variable cost x Sales
volume in units) – Fixed costs

Break-Even point (units) = Fixed Costs ÷ (Sales price per unit – Variable costs per unit) 
where: CM=Contribution margin=Sales−Variable Costs

Examples #1
XYZ wishes to make an annual profit of $100000 from the sale of
appliances. Details of manufacturing and annual capacity are as follows:

Based on the above information, let’s plug the numbers in the CVP
equation:

 10000*p= (10000*30) +$30000+$100000

 10000p = ($300000+$30000+$100000)
 10000p=$430000
 Price per unit= ($430000/10000) = $43
Thus price per unit comes out to $43, which implies that XYZ will have to
price its product $43 and need to sell 10000 units to achieve its targeted
 profit of $100000. Further, we can see that the fixed cost remains
constant ($30000) irrespective of the level of sales.

Examples #2
ABC Limited has entered into the business of making Electrical fans. The
management of the company is interested in knowing the breakeven
point at which there will be no profit/loss. Below are the details
pertaining to the cost incurred:

Solution:

No. of units sold by ABC limited: ($300000/$300) = 1000 units

Variable cost per unit= ($240000/1000)=$240

 Contribution per unit= Selling price per unit-Variable cost per unit
 = ($300-$240)
 = $60 per unit
Break-Even Point= (Fixed Cost/Contribution per unit)

 = ($60000/$60)
 =10000 units
Thus ABC limited the need to sell 10000 units of electric fans to break
even at the current cost structure.

Contribution Margin Ratio = Contribution Margin/Sales

The contribution margin is sales revenue minus all variable costs. It may be calculated using
dollars or on a per unit basis.
QUESTION 4: Calculate BEP

If The Three M's, Inc., has sales of $750,000 and total variable costs of $450,000. Assuming
the company sold 250,000 units during the year & the per unit sales price is $3 and the total
variable cost per unit is $1.80. . Calculate CM & CMR per unit n overall.

Calculate CMR , BEP SAles

CM = Sales – V. C = 750000 -450000 = 3,00000

1. CMR = CM /Sales = 3,00,000/750,000*100 =40%

2. BEP is sales =FC/CMR = 300,000/40% = 750,000

3. Break‐even point in units. = FC /CM @per unit

3,00,000/1.20 = 250,000 per unit

Targeted income
CVP analysis is also used when a company is trying to determine what level of sales
is necessary to reach a specific level of income, also called targeted income. To
calculate the required sales level, the targeted income is added to fixed costs, and
the total is divided by the contribution margin ratio to determine required sales
dollars, or the total is divided by contribution margin per unit to determine the
required sales level in units.
Req. Sales in dollars = (FC +Targeted Income)/CMR

Req. Sales in units = (FC +Targeted Income)/CM @per unit

Example: Using the data from the previous example, what level of sales would be required if
the company wanted $60,000 of income? 

Req. Sales in dollars = (FC +Targeted Income)/CMR

= (3,00,000+ 60,000)/40% = Rs. 9,00,000

Req. Sales in units = (FC +Targeted Income)/CM @per unit

= (3,00,000+ 60,000)/1.20 = 3,00,000 units

Targeted Income After Income tax

This calculation of targeted income assumes it is being calculated for a division as it ignores
income taxes. If a targeted net income (income after taxes) is being calculated, then income
taxes would also be added to fixed costs along with targeted net income.

Req. Sales in dollars = (FC +Targeted Income+ Income Tax)/CMR

Req. Sales in units = (FC +Targeted Income + Income Tax)/CM @per unit

Example :Using the same data, The amount of income taxes used in the calculation is
$40,000.

1. Req. Sales in dollars = (FC +Targeted Income+ Income Tax)/CMR

= (3,00,000+ 60,000 +40,000)/40% = Rs. 1,00,000

2. Req. Sales in units = (FC +Targeted Income+ Income Tax)/CMR @per unit

= (3,00,000+ 60,000 +40,000)/1.20 = 3,33,333 units

Profit-Volume Ratio
Profit / Volume (P/V) ratio is calculated while studying the profitability of operations
of a business and to establish a relation between Sales and Contribution. It is one of
the most important ratios, calculated as under:
P
⁄V Ratio or CMR
= Contribution/Sales
OR = Sales−Variable Cost/Sales
OR = Fixed Expenses +Profit / sales
OR = Change in profits of Contributions/Change in sales
The P/V Ratio shares a direct relation with profits. Higher the P/V ratio, more the
profit and vice-a-versa.

Margin of Safety
Excess of sale at BEP is known as margin of safety. Therefore,
Margin of safety = Actual Sales − Sales at BEP
Margin of safety may be calculated with the help of the following formula:
Margin of Safety = Profit / P/v ratio

OR =  Profit/ Contribution per unit

Example:

Fixed Cost = Rs 2,50,000

Variable Cost = Rs 15 per unit
Selling Price = Rs 25 per unit
Production level in units 12,000, 15,000, 20,000, 25,000, 30,000,
and 40,000.
Calculate:

B.E.P in units , At production level of 25,000 units, the total cost, Statement showing Profit &
Margin of safety at different level of production.
Solution:
1. B.E.P in units = Fixed Cost/ contribution per unit
= Rs 2,50,000 / (25-15)
= Rs 2,50,000 / (10)
= 25,000 units

2. At production level of 25,000 units, the total cost will be

= (25000 × 15) + 2,50000)
= 3,75,000 + 2,50,000
= Rs 6,25,000.

3. Statement showing Profit & Margin of safety at different level of production Break
Even Sale = Rs 6,25,000 = (25,000 x 25) = 6,25,000/25000 = 25

Production Total Sale Total Cost Profit Margin of safety

(In Rs) (In Rs) (Sales - Cost) (Profit/Contribution per unit)
(In Rs) (In Units)
(In Units)

12000 3,00,000 4,30,000 -1,30,000

(12000x15+250000)

15000 3,75,000 4,75,000 -1,00,000

20000 5,00,000 5,50,000 -50,000

25000 6,25,000 6,25,000 (B.E.P) (B.E.P)

30000 7,50,000 7,00,000 50,000 (50,000/10) = 5,000

40000 10,00,000 8,50,000 1,50,000 15,000

Example:
1. Pepsi Company produces a single article. Following cost data is given about its product:‐ 
Selling price per unit       Rs.40
V. cost per unit       Rs.24
 Fixed cost per annum       Rs. 16000
Calculate:       (a)P/V ratio (b) break even sales (c) sales to earn a profit of Rs. 2,000 (d) Profit
at sales of Rs. 60,000 (e) New break even sales, if price is reduced by 10%.

Solution:    We know that (S‐v) /S= F + P   OR   s x P/V Ratio = Contribution So,  

(A) P/V Ratio = Contribution/sales x 100            

 = (40‐24)/40 x 100 = 16/40 x 100 OR 40%
(B) Break even sales 
S = CM/P/v Ratio   (At break even sales, contribution is equal to fixed cost)
S = FC /P/v ratio
Fixed Cost = S x P/V Ratio = S x 40/100 = 16,000
S = 16,000 x 100 / 40 = 40,000 OR 1000 units
(C) The sales to earn a profit of Rs. 2,000
S x P/V Ratio = F + P
S x 40/100 = 16000 + 2000
S = 18,000 x 100/40  
S = Rs. 45,000 OR 1125 units

(D)Profit at sales of 60,000 S x P/V Ratio = F + P

Rs. 60,000 x 40/100 = 16000 + P
24,000 = 16000 + P
24,000 – 16,000 = P
8,000
( E) New break even sales, if sale price is reduced by10%
New sales price = 40‐10%  = 40‐4 = 36
Marginal cost = Rs. 24
Contribution    = (36-24)= Rs. 12
P/V Ratio = Contribution/Sales     = 12/36 x100    OR 33.33%
Now, S x P/V Ratio = F C    
(at B.E.P. contribution is equal to fixed cost)
S x 100/300 = Rs.16000   
S = 16000 x 300/100   
S= Rs.48,000.

Example :
From the following information's find out:
a. P/V Ratio b. Sales & c. Margin of Safety
Fixed Cost = Rs.40, 000
Profit = Rs. 20,000  
B.E.P. = Rs. 80,000
Solution:
a. P/V Ratio.  
BEP Sales = FC/PV Ratio
80,000 = 40,000/x
X=50%
b. Sales.
Sales x P/V Ratio = F+ P
OR Sales x P/V Ratio = Contribution
OR Sales = Contribution/P/V Ratio
So, = (40,000 + 20,000)/50/100 = (60,000 x 100)/50 =Rs.1, 20,000
c. Margin of Safety.
Margin of Safety = Sales – B.E.P Sales
So, MOS = 1, 20,000 – 80,000 MOS = Rs.40, 000

Example : - From the following data, you are required to calculate:

(a) P/V ratio
(b) Break-even sales with the help of P/V ratio.
(c) Sales required to earn a profit of Rs. 4,50,000
Fixed Expenses = Rs. 90,000
Variable Cost per unit:
Direct Material = Rs. 5
Direct Labour = Rs. 2
Direct Overheads = 100% of Direct Labour
Selling Price per unit = Rs. 12.

Example : -From the following data, you are required to calculate break-
even point and net sales value at this point:
If sales are 10% and 25% above the break even volume, determine the net profits.
SOLUTION:
Selling Price per unit 25
- Trade discout (25X4/100) 1
Net Selling price 24
- V.C
D. Labour 5
D. Material 10
Vari. Overheads 3 (5X60/100) 18
Contri. Per unit 6
BEP ( in units) FC/ Contri. Per unit = 50,000/6 = 8333 units

BEP ( in Sales) = FC / P/V Ratio

P/V Ratio = (contr. /sales )x100 = (6/24) x 100 = 25%
Therefore BEP S. = 50,000/25% = 2,00,000
Profit when sales is 10% above Break-even Value:
Sales = 2,00,000 + (2,00,000 x10%) = 2,20,000
Contribution = sales / p/v Ratio = 2,20,000 /25% = 55,000
Contribution = FC + Profit
55,000 = 50,000 + profit
Profit = 5,000
Profit when sales is 25% above Break-even Value:
Sales = 2,00,000 + (2,00,000 x25%) = 2,50,000
Therefore BEP S. = 2,50,000/25% = 62,500
Contribution = FC + Profit
62,500= 50,000 + profit
Profit = 12,500

case Study - 1
A manufacturing company produces Ball Pens that are printed with the logos of various
companies. Each Pen is priced at `5.
Costs are as follows:
Cost Driver Unit Variable Cost (`) Level of Cost Driver
Units Sold 2.5
Setups 225 40
Engineering hours 10 250
Other Data
Total Fixed Costs (conventional)………………………………..` 48,000
Total Fixed Costs (ABC)………………………………………….` 36,500
Required (i) Compute the break-even point in units using activity-based analysis.
(ii) Suppose that company could reduce the setup cost by ` 75 per setup and could reduce
the number of engineering hours needed to 215. How many units must be sold to break
even in this case?
Solution:
Break Even Units
1. [Fixed Costs + (Setup Cost ×Setups) + (Engineering Cost ×Engineering Hours)]/ (Sale
Price − Variable Cost)
= [36,500 + (` 225 × 40) + (`10 × 250)] / (` 5 – ` 2.5) = 19,200 units
2. [Fixed Costs + (Setup Cost ×Setups) + (Engineering Cost ×Engineering Hours)]/ (Sale
Price − Variable Cost)
= [36,500 + (`150 × 40) + (`10 × 215)] / (` 5 – ` 2.5) = 17,860 Units