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SUBMITED BY:

RITTIK YADAV-053 [Pages 2-6]

SABYASACHI BHATTACHARJEE-087 [Pages 6-11]
SAYAN MAJI-089 [Pages 12-13]
KINGSUK SAHA-056 [Pages 14-16]
SAMANNAYA PAUL-119 [Pages 16-18]

AMITY BUSINESS SCHOOL

COURSE: MBA [2022-2024]

SUBJECT: ACCOUNTING FOR MANAGERS [ACCT602]
SECTION: B
SEMESTER: 1
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Introduction

Cost Volume Profit (CVP) analysis is a method of examining how changes in variable and

fixed costs affect a firm's profits. A company can use it’s CVP to see the break-even point

(covering all costs) or the number of units that need to be sold to meet a certain minimum

profit margin. CVP analysis makes several assumptions, such as constant selling price, fixed

and variable costs per unit.

Cost-volume-profit analysis, also called break-even analysis, attempts to determine the break-

even point for various sales volumes and cost structures. This helps managers make short-

term business decisions. To perform a CVP analysis, multiple equations must be used for

prices, costs, and other variables and plotted on economic charts. CVP analysis also manages

product contribution margins. Contribution margin is the difference between total revenue

and total variable costs. Contribution margins must exceed total fixed costs for a business to

be profitable. Contribution margin can also be calculated per unit. The unit contribution

margin is the remainder after deducting the unit variable costs from the unit selling price.

Contribution margin ratio is contribution margin divided by total sales.

Contribution margin is used to determine the break-even point. You can calculate your

breakeven point in gross dollars by dividing your total fixed costs by your contribution

margin ratio. For example, a company with fixed costs of $100,000 and a contribution margin

of 40% must generate revenue of $250,000 to break even.

You can add the profit to the fixed cost and perform a CVP analysis of the desired outcome.

For example, if the previous company wanted a profit of €50,000, the total turnover required

would be €150,000 (fixed costs plus desired margin) divided by a contribution margin of

40%. In this example, $375,000 in revenue is required.

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Uses of 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. CPV analysis is a powerful tool that

helps managers understands the relationships of cost volume and profit. It deals with how

operating profit is affected by changes in variable costs, fixed costs, selling price per unit and

the sales mix of two or more different products

Components of CVP Analysis

There are several different components that together make up CVP analysis. These

components involve various calculations and ratios, which will be broken down in more

detail in this guide.

The main components of CVP analysis are:

1. CM ratio and variable expense ratio

2. Break-even point (in units or dollars)

3. Margin of safety

4. Changes in net income

5. Degree of operating leverage

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1. CM ratio:- Contribution margin ratio (DB ratio) is the ratio of contribution margin to

sales. Shows the percentage of sales available to cover fixed costs and generate profit.

Variable expenses ratio:- Variable expense ratio is also called the variable cost ratio

i.e it is a means of understanding how variable costs impact on business’s net profits.

Variable Expense Ratio = Total Variable Costs / Sales

2. BEP (in units or dollars):- The break-even point (BEP), in units, is the number of

products that the company must sell to makeup all their production costs. Similarly, the

break-even point in dollars is the amount of sales the company must create to cover all

their production costs (variable and fixed costs).

The formula for break-even point (BEP) is:

BEP =Total Fixed Costs / CM per Unit

The BEP, in units, would be equal to 240,000/15 = 16,000 units. Therefore, if the

company sells 16,000 units, the profit will be zero and the company will “break even”

and only cover its production costs.

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3. Changes in Net Income (What-if Analysis)

It is quite common for companies to want to estimate how their net income will change with

changes in sales behaviour. For example, companies can use sales performance targets or net

income targets to determine their effect on each other.

In this example, if management wants to earn a profit of at least $100,000, how many units

must the company sell?

We can apply the appropriate what-if formula below:

No. of units = (Fixed Costs + Target Profit) / CM Ratio

Therefore, to earn at least $100,000 in net income, the company must sell at least 22,666

units.

4. Margin of Safety

In addition, companies may also want to calculate the margin of safety. This is commonly

referred to as the company’s “wiggle room” and shows by how much sales can drop and yet

still break even.

The formula for the margin of safety is:

Margin of Safety = Actual Sales – Break-even Sales

The margin of safety in this example is:

Actual Sales – Break-even Sales = $1,200,000 – 16,000*$60 = $240,000

This margin can also be calculated as a percentage in relation to

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actual sales: 240,000/1,200,000 = 20%.Therefore, sales can drop by $240,000, or 20%, and

the company is still not losing any money.

5. Degree of Operating Leverage (DOL)

Finally, the degree of operating leverage (DOL) can be calculated using the following

formula:

DOL = CM / Net Income

So, the DOL in this example is $300,000 / 60,000 = 5.

The DOL number is an important number because it tells companies how net income changes

in relation to changes in sales numbers. More specifically, the number 5 means that a 1%

change in sales will cause a magnified 5% change in net income.Many might think that the

higher the DOL, the better for companies. However, the higher the number, the higher the

risk, because a higher DOL also means that a 1% decrease in sales will cause a magnified,

larger decrease in net income, ultimately decreasing its profitability.

How does CVP analysis help in managerial decision making?

Every organization needs to calculate future revenues in order to help the managers carry out

their operations effectively. Cost volume is the approach used for this purpose. Cost Volume

Profit analysis or CVP analysis helps in identifying the operating activity levels with a

purpose to avoid any kind of losses and achieve profits. Moreover, it also helps the

companies to plan their future operations and see whether their organizational performance is

going on the right track or not. While conducting a business, the companies also have to face

various risks and in order to counter those risks, CVP analysis is an effective tool.

Cost volume profit analysis can also help the organizations in calculating the breakeven point

which is the point at which the profits become equal to zero. This can be done by finding the
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break even volume and then using it to make graphical representations. The break even

volume can either be expressed in dollars or in units depending upon the nature and type of

the organization. For instance: if the organization makes a large amounts of products, then the

company must prefer to calculate the breakeven volume in the form of sales dollars while in

case of one product company, the unit method might be a more effective calculation of sales

volume. The calculation method and the graphical representation in both cases:

1. Break even volume in unit method = Fixed costs/Unit contribution margin

2. Break even volume in sales dollar method = Fixed costs/Contribution margin ratio

At the breakeven point, the profits of the company become zero and below this point, the

company begins to incur losses. So, it is a beneficial tool for the organizations which help

them to analyze what should be the target ad how this target can be achieved by managing the

fixed as well as variable costs and also by preparing a plan for the future operations.
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Benefits of Cost Volume Profit Analysis

Cost Volume Profit analysis helps organizations to examine their profits, costs and prices

with respect to any changed that occur in sales volume. CVP is an effective tool that helps

accountants to engage in decision making regarding future operations (Breakeven analysis).

Moreover, it also helps in making the following decisions for the company:

 It helps to analyze which products and services are beneficial and how can company use

these products and services to generate the maximum amount of revenue.

 It also explains what sales volume will be needed by the company in order to achieve a fixed

level of profits.

 Moreover, it tells how much revenue should the company target so as to make sure that no

losses occur.

 It also highlights what would be expected budget of the company.

 It also helps to calculate company’s fixed costs and measure the amount of risk associated

with any investment.

Operating Leverage

Another benefit that companies gain by using the CVP approach is the operating leverage

benefit which explains how the cost structure of an organization is made up of fixed cost

processes. This is a huge benefit because the cost structure is directly related to the level of

growth and profit a company has. Operating leverage can vary greatly from one company to

another. In the firms that have a high ratio of fixed costs as compared to the variable costs,

the operating leverage is good because it produces a high contribution margin. Similarly,

higher fixed sales also mean that the company has a higher breakeven point. A higher
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breakeven point is directly related to the financial success of the company because at this

point, the company can claim high profits at a much higher rate.

Income Tax Benefits

Similarly, the simple CVP model can be extended to other issues such as the calculation of

incorporate taxes of multiple products within a company. This is done by modifying the

profit equation of the chart to include taxes as well. This analysis can also be extended to

those firms that offer more than one product or service rather than a simple product.

Future Forecasting

By using the above mentioned models, approaches and graphs, managers can analyze the

direction in which their company is moving and this analysis might help them to better

understand the different operations and activities within the organizations. By getting

beforehand knowledge of profits and costs, the company can manage them in a more efficient

way to increase productivity.

Preparation of Budgets

Since the cost profit volume analysis helps in determining the level of sales and thus helps

organizations to achieve their desired targets. This approach would help the managers

to prepare their budgets which consist of the costs as well as the revenues at any level of

production within the organization.

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Cost Control

The biggest benefit of CVP analysis is to evaluate the cost volume changes within an

organization and the impact of these changes on revenue generation. For instance: there is a

dental hospital that wants to purchase a new dental machine so that the patient’s level of

satisfaction can be increased by reducing the time required for dental treatment. The purchase

of this new machine will tend to increase fixed costs of an organization. So, at such complex

situations, the cost volume analysis can be the most effective tool to help in simplifying the

company’s decision. If this dental hospital uses CVP analysis, it can manage to decrease its

variable costs by maintain the profit at the same desired level.

Price Determination

It is another benefit of using this approach. For example: If any competitor within the dental

industry has set the price at Rs.50,000 for a single dental operation and the business cannot

provide this operation at any cost lower than Rs.20,000, then the company can use cost profit

volume analysis to compare the competitor’s price with the fixed and variable costs of its

own operations and thus it can manage to come up with a price that is in the best interest of

the company.

Profit Planning

The aim of any business is to create value for the customers and to get profits for the

company. However, managing all operations and costs in such a way that can maximize

profits is not an easy task. Therefore, organizations have to consider a lot of things in order to

engage in proper profit planning techniques. The CVP analysis can help the companies to

create the best and most profitable combination of cost, price and sales volume. Thus, it can
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help managers to calculate and estimate their profit at different levels and for different range

of products.

Risk Assessment

The business world is changing and due to several internal s well as external threats

associated with any industry, businesses have to face too many risks. Although the

calculation of risk and return through measuring a constant (beta) is a method in finance but

managerial accounting is also concerned with this. Managing risk is too significant for any

business because it tends to define all the procedures and practices involved within an

organization.

Therefore, CVP is a tool which helps to calculate risk particularly in terms of costs and

volumes. After analyzing this risk, the companies can come up with efficient solutions to

reduce this risk.

Decision Making

All the above mentioned benefits of Cost Volume Profit Analysis directly or indirectly

related to the decision making processes of a company. Any business organization has to

make a lot of decisions regarding their price, their costs, and products, fixed and variable unit

costs and so on. The CVP approach simplifies this process by providing the companies with a

breakeven point and by helping them to engage in better decision making and planning for

the future.
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Examples of CVP Problems with Solutions

A. Rory Ltd manufactures and sells remote control cars. You have been provided with the

following information:

Each car sells for Rs.100

Variable costs per car Rs.60
Fixed costs (per annum) Rs.1,00,0
00
Any profits are taxed at 30%

Required:

1. What is the firm’s break‐even point in terms of units sold?

2. What is the firm’s break‐even point in terms of Rs. value?

3. How much profit would the firm make (before tax) if 3,000 cars were sold?

4. What would the firm’s margin of safety be if 3,000 cars were sold?

5. What would the firm’s margin of safety ratio be if 3,000 cars were sold?

6. How many cars would the firm have to sell in order to make a profit of Rs.14000 after

tax?

7. How many cars would he have to sell to make a return on sales equal to 15%?
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SOLUTION

Per unit % Variable % Per unit

($) profit (%) ($)
Selling price Rs.100 100% 100% Rs.100
Less: Variable costs Rs.60 60% + 15% = 75% Rs.75
Contribution margin Rs.40 40% ‐ 15% = 25% Rs.25
(CMR) (CMR)

1.

BEP (units)

= Total FC / CM per unit

= Rs.1,00,000 / Rs.40

= 2,500 units

2.

BEP (in Rs.)

= Total FC / CMR

= Rs.1,00,000 / 0.40

= Rs.2,50,000

3.

Profit (before tax) if 3,000 cars sold

= (Selling price per unit x Units sold) ‐ (Variable cost per unit x Units sold) – Total fixed
costs
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= (Rs.100 x 3,000) ‐ (Rs.60 x 3,000)‐ Rs.100,000

= Rs.300,000 ‐ Rs.180,000 ‐ Rs.100,000

= Rs.20,000

4.

Margin of safety if 3,000 cars sold

= Sales (actual units) – Sales (break‐even units)

= 3,000 units – 2,500 units

= 500 units

5.

Margin of safety ratio if 3,000 cars sold

= Margin of safety (units) / Actual sales (units)

= 500 units / 3,000 units

= 16.7%

This means that the firm’s sales volume can drop by 16.7% before the firm incurs a loss

(other things held constant).

6.

Here you first need to convert the after‐tax profit figure into a before ‐tax profit figure as

follows:
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Before‐tax profit

= After‐tax profit / (1 – tax rate)

= Rs.14,000 / (1 – 0.30)

= Rs.14,000 / 0.70

= Rs.20,000

Target sales (units)

= (Total FC + Target profit before tax) / CM per unit

= (Rs.100,000 + Rs.20,000) / Rs.40

= Rs.120,000 / Rs.40 = 3,000 units

B. Assume that as an investor, you are planning to enter the construction industry as a panel

formwork supplier. The potential number of forthcoming projects, you forecasted that within

two years, your fixed cost for producing formworks is Rs. 300,000. The variable unit cost for

making one panel is Rs. 15. The sale price for each panel will be Rs. 25. If you charge Rs.

25 for each panel, how many panels you need to sell in total, in order to start making money?

Solution:
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Answer: Break-Even in Units = 30,000 panels

C. Suppose you intend to open a franchise business to supply a nationally-

known line of women’s shoes. You’ve found a good location in Abbottabad

to open your shop, and have determined that the average prices and costs of

operating the store are:

Price = Rs. 50 per pair, Cost = Rs. 30 per pair, Rent = Rs. 2,500 per month,

Insurance = Rs. 500 per month, Utilities & Telephone = Rs. 300 per month.

In addition, you plan to hire two sales ladies on a commission basis of 10%

in order to provide them with incentive to sell shoes. You are required

determine the breakeven point in Rupees?

Solution:
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Answer: Break-Even in Rupees = Rs. 11,000

D. A store sells t-shirts. The average selling price is Rs. 15 and the average variable cost

(cost price) is Rs. 9. Thus, every time the store sells a shirt it has Rs. 6 remaining after it

pays the manufacturer. This Rs. 6 is referred to as the unit contribution.

(a) Suppose the fixed costs of operating the store (its operating expenses) are Rs. 100,000 per

year. Find Break-even in units?

(b) If the owner desired a profit of Rs. 25,000, what will be break-even point in Rupees?

(c) If fixed costs rose to Rs. 110,000, break-even in units volume would be?

(d) If the average selling price rose to Rs.16, break even volume would fall?

Solution:

(a)

Answer: Break-Even in Units = 16,667 T-shirts

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(b)

Answer: Break-Even in Rupees = Rs.16,667

(c)

Answer: Break-Even in Units = 18,333 T-shirts

(d)

Answer: Break-Even in Volume = 14,286 T-shirts

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