COST-VOLUME-PROFIT ANALYSIS

LESSON 13
 CVP ANALYSIS AND BREAKEVEN POINT
• Cost volume profit analysis is the study of the
interrelationship between costs, volume and profit at
various levels of activity.
• The management of an organisation usually wishes to know
the profit likely to be made if the aimed for production and
sales for the year are achieved. Management may also be
interested to know the following:
(a) The breakeven point which is the activity level at which
there is neither profit nor loss.
(b) The amount by which actual sales can fall below anticipated
sales, without a loss being incurred.
 CVP ANALYSIS AND BREAKEVEN POINT

•   breakeven(BEP) point can be calculated arithmetically.

The

Example
Expected sales 10000 units at $8= $80000
Variable costs $5 per unit
Fixed costs $21000
REQUIRED
Calculate the breakeven point.
 THE CONTRIBUTION/SALES RATIO
•   C/S ratio is a measure of how much contribution is
The
earned from each $1 of sales. The C/S ratio is calculated as
follows:
C/S =
Example
Expected sales 10,000 units @$8 =$80000
Variable cost $5 per unit
Fixed costs $21, 000
REQUIRED
Calculate the C/S ratio
 AN ALTERNATIVE METHOD TO CALCULATE
BREAKEVEN
•An  alternative way of calculating breakeven
point to give an answer in terms of sales
revenue is as follows:
 THE MARGIN OF SAFETY
• The margin of safety is the difference in units
between the expected sales volume and the
breakeven sales volume and it is sometimes
expressed as a percentage of the expected sales
volume.
• The margin of safety may also be expressed as the
difference between the expected/actual sales
revenue and breakeven sales revenue, expressed as
a percentage of the expected/actual sales revenue.
 THE MARGIN OF SAFETY
Example
Mal d Mer Co makes and sells a product which
has a variable cost of $30 and which sells for
$40. budgeted fixed costs are $70,000 and
expected sales are 8,000 units.
REQUIRED
Calculate the breakeven point and margin of
safety.
 BREAKEVEN ARITHMETIC AND TARGET
PROFITS
• At breakeven point, sales = total variable costs + total fixed costs.
• Subtracting variable costs from each side of the equation, we get:
• Sales – total variable cost = fixed costs
• Total contribution = fixed costs
Example
Butterfingers Co makes a product which has a variable cost of $7
per unit.
REQUIRED
If fixed costs are $63,000 per annum, calculate the selling price per
unit if the company wishes to breakeven with sales volume of
12,000 units.
 TARGET PROFITS
A similar formula may be used where a company
wishes to achieve a certain profit during a period. To
achieve this profit, sales must cover all costs and
leave the required profit.
The target profit is achieved when: S = V + F + P
Where P = required profit.
Subtracting V from each side of the equation, we get
S–V=F+P
Total contribution required = F + P
 TARGET PROFITS
Example: Target profits
Riding Breeches Co makes and sells a single product, for which
costs are as follows:
$
Direct materials 10
Direct labour 8
Variable production overhead 6
24
The sales price is $30 per unit, and fixed costs per annum are
$68,000. the company wishes to make a profit of $16,000 per
annum.
REQUIRED
Determine the sales required to achieve this profit.
 EXERCISE
Seven league boots Co wishes to sell 14,000
units of its product, which has a variable cost of
$15 to make and sell. Fixed costs are $47,000
and the required profit is $23,000.
REQUIRED
Calculate the sales price per unit.
 DECISIONS TO CHANGE SALES PRICE OR
COSTS
You may come across a problem in which you will be expected to
offer advice as to the effect of altering the selling price, variable cost
per unit or fixed cost. Such problems are slight variations on basic
breakeven arithmetic.
Example
Stomer Cakes Co bake and sell a single type of cake. The variable cost
of production is 15c and the current sales price is 25c. Fixed costs are
$2,600 per month, and the annual profit for the company at current
sales volume is $36,000. The volume of sales demand is constant
throughout the year. The sales manager Ian Digestion, wishes to raise
the sales price to 29c per cake, but considers that a price rise will
result in some loss of sales.
REQUIRED
Ascertain the minimum volume of sales required each month to raise
the price to 29c
 Example 2: change in production costs
Close Brickett Co makes a product which has a variable production cost
of $8 and a variable sales cost of $2 per unit. Fixed costs are $40,000 per
annum, the sales price per unit is $18, and the current volume of output
and sales is 6,000 units.
The company is considering whether to have an improved machine for
production. Annual hire costs would be $10,000 and it is expected that
the variable cost of production would fall to $6 per unit.
REQUIRED
(a) Determine the number of units that must be produced and sold to
achieve the same profit as is currently earned, if the machine is hired.
(b)Calculate the annual profit with the machine if output and sales
remain at 6,000 units per annum.
 SALES PRICE AND SALES VOLUME
It may be clear by now that, given no change in fixed costs,
total profit is maximised when the total contribution is at its
maximum. Total contribution in turn depends on the unit
contribution and on the sales volume.
An increase in the sales price will increase unit contribution,
but sales volume is likely to fall because fewer customers will
be prepared to pay the higher price. A decrease in sales
price will decrease the unit contribution, but sales volume
may increase because the goods on offer are now cheaper.
The optimum contribution of sales price and sales volume is
arguably the one which maximises total contribution.
 Example: profit maximisation
MME Co has developed a new product which is about to be
launched on the market. The variable cost of selling the product
is $12 per unit. The marketing department has estimated that
at a sales price of $20, annual demand would be 10,000 units.
However, if the sales price is set above $20, sales demand
would fall by 500 units for each 50c increase above $20.
Similarly, if the price is set below $20, demand will increase by
500 units for each 50c stepped reduction in price below $20.
REQUIRED
Determine the price which would maximise MME Co,s profit in
the next year.
 EXERCISE
Betty Battle Co manufactures a product which has a selling
price of $20 and a variable cost of $10 per unit. The
company incurs annual fixed costs of $29,000. annual sales
demand is 9,000 units.
New production methods are under consideration, which
would cause a $1,000 increase in fixed costs and a reduction
in variable cost to $$9 per unit. The new production
methods would result in a superior product and would
enable sales to be increased to 9,750 units per annum at a
price of $21 each. If the change in production methods were
to take place, what would be the breakeven output level?
 BREAKEVEN CHARTS AND PROFIT/VOLUME
CHARTS
• The breakeven point can also be determined graphically
using a breakeven chart or contribution breakeven chart.
• The profit volume chart is a variation of the breakeven chart
which illustrates the relationship of profits to sales.
BREAKEVEN CHART
This a chart which shows approximate levels of profit or loss at
different sales volume levels within a limited range.
A breakeven chart has the following axes.
• A horizontal axis showing the sales/output(in value or units)
• A vertical axis showing $ for sales revenues and costs.
 BREAKEVEN CHARTS
The following lines are drawn on a breakeven chart:
(a) The sales line
• starts at the origin
• Ends at the point signifying expected sales
(b)The fixed cost line
• Runs parallel to the horizontal line
• Meets the vertical axis at a point which represents total fixed
costs.
©The total cost line
• Starts where the total fixed costs line meets the vertical axis.
• Ends at the point which represents anticipated sales on the
horizontal axis and total costs of anticipated sales on the
vertical axis.
 BREAKEVEN CHARTS
The breakeven point is the intersection of the sales line and
the total costs line. The distance between the breakeven point
and the expected (or budgeted) sales, in units, indicates the
margin of safety.
Example
The budgeted annual output of a factory is 120,000 units. The
annual fixed overheads amount to $40,000 and the variable
costs are 50c per unit. The sales price is $1 per unit.
REQUIRED
Construct a breakeven chart based on annual output upto
120,000.
 THE PROFIT/VOLUME(PV) CHART
• A P/V chart is a variation of the breakeven chart which illustrates the
relationships of profit to sales.
• A P/V chart is constructed as follows:
(a) P is on the y axis and actually comprises not only profit but contribution to
profit extending below and above the x axis with a zero point at the
intersection of the two axes , and the negative section below the X axis
representing fixed costs. This means that at zero production , the firm is
incurring a loss equal to the fixed costs.
(b) V is on the x axis and comprises either volume of sales or value of
sales(revenue)
(c) The profit-volume line is a straight line drawn with its starting point at the
intercept on the y axis representing the level of fixed costs, and with a
gradient of contribution/unit. The PV line will cut X axis at the breakeven
point of sales volume.
 THE PROFIT/VOLUME(PV) CHART
Let us draw a P/V chart for our previous
example. At 120,000 units, total contribution is
$60,000 and total profit is $20,000.
 LIMITATIONS OF CVP ANALYSIS
• It can only apply to a single product or a single mix of group of
products
• A breakeven chart may be time consuming to prepare
• It assumes fixed costs are constant at all levels of output.
• It assumes that variable costs are the same per unit at all
levels of output.
• It assumes that sales prices are constant at all levels of output.
• It assumes production and sales are the same
• It ignores uncertainty in the estimates of fixed costs and
variable costs per unit.