CVP Analysis

CONTENT
CVP Analysis
Contribution
PV Ratio
Break Even Analysis
Margin of Safety
Desired Sales for Target Profit
Practical Exercise
 CVP Analysis
CVP analysis is a profit planning technique which is generally
used by the managers to study the impact of change in cost
and volume of sales on the profitability of the enterprise.
CVP tries to answer the following types of questions:
1. At what minimum level of sales, the total cost is recovered
and the enterprise avoids the losses?
2. How much sales is required to achieve the target amount of
profit?
3. What shall be the effect of change in variable cost and fixed
cost on the profitability of the firm?
4. How does the change in selling price impact the volume of
sales and the profits?
It studies the relationship between the 3 inter-
connected factors that act and react on one
another due to cause and effect relationship
among them.
CVP Analysis is defined as

“ the study of the effects on future profits of

changes in fixed cost, variable cost, sales price,
quantity and mix”

- CIMA London
Cost of product determines its selling price and the selling price
determines the level of profit.

Selling Price affects Volume of Sales which directly affects volume of

production and volume of production in turn influences cost.

The analysis helps management in budgeting and profit planning.

It explains the impact of changes in selling prices, volume of sales,

variable cost and fixed cost.
 Contribution
C is the surplus generated by the product sold after the
recovery of its variable cost.
It is the amount available from each unit sold for the recovery
of fixed cost and profit.
Also know as contribution margin
Contribution (p.u.) = S.P. (p.u.) – Variable cost (p.u.)

Total contribution = Contribution (p.u.) * no. of unit sold

OR
Total sales – total variable cost
OR
Fixed cost + profit
Contribution = Sales – Variable Cost
( C = S - V)
OR
Fixed Cost + Profit (C = F + P)
OR
Fixed Cost – Loss (C= F – L)
S - V = F + P
Assume Sales are Rs. 12,000, Variable
cost Rs. 7,000 and Fixed cost Rs. 4,000.
Determine what will be the Profit?
Assume the Sales of XYZ Ltd. Is
Rs. 18,000, Variable cost Rs.
9,000 and Fixed cost Rs. 5,000.
Determine what will be its
Profit?
Assume the Sales of XYZ
Ltd. Is Rs. 18,000, Variable
cost Rs. 9,000 and Profit
Rs. 4,000.
Determine what will be its
Fixed Cost?
 PV Ratio
Profit-volume ratio/contribution margin ratio expresses
contribution as a % of sales.
It shows the proportion of contribution in the given sales.
A higher P/V ratio shows higher proportion of contribution in
the given sales.
A higher P/V ratio is an indicator of higher profitability.
 Important ratio for business

Higher the ratio

PROFIT – VOLUME RATIO (P/V RATIO or
higher the
Contribution/Sales ratio – c/s ratio)
profitability

One can check profitability of different sections of business likes sales,

classes of customers, product line, methods of production etc.
P/V RATIO = Contribution
Sales

Or

C/ S

Or

Sales – variable Cost

Sales
 Derivation of formulas :

P/V RATIO = Contribution

Sales

Suppose in a question Contribution is missing, how can you still calculate

its amount:

P/V RATIO = Contribution

Sales

Now, Sales = Contribution

P/V Ratio

Contribution = Sales x P/V Ratio

Assume Sales of a Company are Rs. 20,000;
Variable Cost Rs. 8,000.

Calculate P/V Ratio.

P/V Ratio = S-V/S = 20,000 – 8,000/ 20,000 = 60%
Assume a Company has Sales Rs. 25,000 and P/V ratio as 30%. Calculate
Contribution.

Contribution = Sales x P/V Ratio

= 25,000 * 30%
= = 7,500 Rs.
 Break Even Analysis
• BEP refers to that level of quantity sold where the total
revenues are equal to the total costs.
• At this level of sales, the total cost is recovered and there is
no profit no loss.
• In this level of sales from where additional units sold will
start generating the profits.
• Any level of sales above BEP gives profits, while any level of
sales below the BEP results into losses.

All costs that must be paid are paid.

 Determine that level of
production and sales where
there is no profit no loss

Total Cost = Total Revenue

Narrow
sense Determine probable
profit/loss at any
Meaning given level of
of Break – production/sales
even (amount of sales
analysis required to earn a
desired level of
Broader profit)
Sense
 Break Even Point
The BEP may be computed by two methods:

a) Algebraic calculations

b) Graphic presentation (Break Even Chart)

 Assumptions of Break Even Point
1. The fixed cost remains constant at all the levels of output.
True only for a given level of capacity.
2. The variable cost p.u. remains constant.
3. The selling price p.u. remains constant. It implies that the
price will not change according to demand-supply
conditions.
4. All semi variable costs can be precisely divided into fixed
and variable.
BREAK – EVEN POINT Widely
used
technique
to study
CVP
Analysis
 Volume of
output or
Sales at which
Output is
exactly equal A point
to Sales of no
profit
or loss

The point of
production at
Break – which total
even cost is covered
point and after this
point profit
begins.
Break-even point is important for every business
because it tells business owners and
managers how much sales are needed to
cover all fixed as well as variable expenses of
the business or the sales volume after which
the business will start generating profit.
 Break Even Chart
Steps involved:
1. Select a scale for sales (units) on the x-axis.
2. Select a scale for costs and revenues on the y-axis.
3. Draw fixed cost line parallel to the x-axis.
4. Draw the total cost line, starting from the point on the y-axis,
which represents fixed costs.
5. Draw the sales line, starting from the point of origin (zero) and
finishing at the point of maximum sales.
6. The sales line will cut the total cost line at the point where the
total cost is equal to total revenues.
7. The point of intersection of these two lines is called the BEP
i.e., the point of no profit no loss.
8. The perpendiculars drawn from the point of intersection to the
x-axis gives the BEP in units and the line drawn to the y-axis
gives the BEP in rupee terms.
 Break Even Chart
Output Sales Variable Cost Fixed Cost Total Cost Profit/Loss
0 - - 8,000 8,000 (8,000)
500 10,000 6,000 8,000 14,000 (4,000)
1,000 20,000 12,000 8,000 20,000 0

1,500 30,000 18,000 8,000 26,000 4,000

2,000 40,000 24,000 8,000 32,000 8,000

2,500 50,000 30,000 8,000 38,000 12,000

 Angle of Incidence
• The angle formed by the total sales line and the total cost
line at BEP is known as AOI.

• The larger the angle of incidence indicates a higher rate of

profit beyond the BEP and vice-varsa.
Can there be two BEP???
 Profit-Volume Chart (PV Chart)
• Profit or loss is shown on the y-axis and the sales revenue
is shown on the x-axis.
• Profit line.
• The point of intersection of the x-axis and the profit line
shows the BEP.
 Desired Sales for Target Profit
The level of sales required to earn the target amount of profit
is called desired sales.
 Margin of Safety
• The excess of actual sales over the break-even sales.
• Any sales above BEP, the contribution is equal to profit.
• A higher MOS is always desirable as it represents the strength of
the firm to face the declining sales.

MOS can be improved by adopting following:

 Increase in sales volume
 Increase in selling price
 Change in product mix to increase contribution
 Lowering fixed cost
 Lowering variable cost
 CVP Analysis uses
1. Effect of change in fixed cost

2. Effect of change in variable cost

3. Effect of change in selling price

4. Effect of change in sales volume (Quantity)

5. Effect of multiple changes

Determine the Contribution, assuming fixed Cost is Rs. 10,000; profit Rs. 6,500:

a) Rs. 3,500

b) Rs. 4,500

c) Rs. 15,500

d) Rs. 16,500
Determine Contribution assuming Variable Cost is RS. 7,500 and Sales Rs. 15,000:

a) Rs. 7,500

b) Rs. 8,500

c) Rs. 15,500

d) Rs. 22,500
High Margin of Safety means:
a) Greater chances of Company to survive
b) Business can still make profits after serious fall
in sales-better chances to survive in depression
c) All of the above
Assume Profit is 20%, P/V ratio 40%,then Margin
of Safety will be:
a) 20%
b) 30%
c) 40%
d) 50%