MANAGEMENT ACCOUNTING FOR

BUSINESS

COST-VOLUME-PROFIT ANALYSIS
 OUTLINE

Definition and techniques

Calculation of break-even point
Margin of Safety
Contribution/Sales Ratio
Determination of sales required for a
Target Profit

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 COST-VOLUME-PROFIT (CVP) ANALYSIS

 Cost–volume–profit (CVP) analysis is defined as the ‘study

of the effects on future profit of changes in fixed cost,
variable cost, sales price, quantity and mix’.
 This is the term given to the study of inter-relationship
between cost, volume and profit at various levels of
activities.
 A common term used for this type of analysis is breakeven
analysis.
 Hence the terms ‘breakeven analysis’ and ‘CVP analysis’
tend to be used interchangeably.

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 BREAK-EVEN POINT
The Break-Even-Point is the level of activity where
there no profit or loss.

It is the point where the full cost of production would

be recovered and any further increase in level of
activity could lead to profit.
CVP analysis uses many of the principles of Marginal
Costing and is an important tool in SHORT TERM
PLANNING.
It explores the relationship which exist between Costs,
Revenue, Output levels and resulting profits
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 ASSUMPTIONS BEHIND CVP ANALYSIS
1. All cost can be revolved into Fixed and Variable element.
2. Fixed cost will remain constant and variable cost vary proportionately
with activity
3. Over that activity range being considered cost and revenue behave in
linear fashion
4. That the only factor affecting cost and revenue is volume
5. That technology, production methods and efficiency remain unchanged
6. Particular for graphical methods the analysis relates to one product
only.
7. There are no stock level changes or that stocks are valued at marginal
cost only

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 THE CONCEPT OF CONTRIBUTION
We have earlier learnt that variable costs are those that vary with the level of
activity.
If we can identify the variable costs associated with producing and selling a
product or service we can highlight a very important measure: contribution.
Contribution =sales value - variable costs
Variable costs are sometimes referred to as marginal costs and the two terms
are often used interchangeably.
Contribution is so called because it literally does contribute towards fixed
costs and profit.
Once the contribution from a product or service has been calculated, the fixed
costs associated with the product or service can be deducted to determine the
profit for the period.

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 COST VOLUME PROFIT ANALYSIS BY FORMULA
 CVP analysis can be undertaken by graphical presentation
or by a simple formula.
 The following formulas are applicable

1. Break-even Point (units) = Required Contribution

Contribution per unit

2. Break-even Point (Sales) = Required Contribution X Selling Price per Unit

Contribution per unit

3. Contribution/Sales Ratio = Contribution per unit X 100

Selling Price per unit

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 COST VOLUME PROFIT ANALYSIS BY FORMULA
4. Level of Sales to result in target profit (units)
= Required Contribution + target profit
Contribution per unit

5. Level of Sales to result in target profit (sales)

= Required Contribution + (target profit x SP per unit)
Contribution per unit

Required Contribution is the contribution required to cover

the fixed cost resulting in no profit or Loss therefore required
contribution is equal to Total Fixed Cost.

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 CALCULATING THE BREAKEVEN POINT
As sales revenues grow from zero, the contribution also
grows until it just covers the fixed costs.
This is the breakeven point where neither profits nor
losses are made.
It follows that to break even the amount of contribution
must exactly match the amount of fixed costs.
If we know how much contribution is earned from each
unit sold, then we can calculate the number of units
required to break even as follows:
Breakeven point in units = Fixed costs
Contribution per unit
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 CALCULATING THE BREAKEVEN POINT
For example, suppose that an organisation
manufactures a single product, incurring variable
costs of GHS30 per unit and fixed costs of
GHS20,000 per month.
If the product sells for GHS50 per unit, then the
breakeven point can be calculated as follows:
Breakeven point in units = GH¢20,000
GH¢50-GH¢30
= 1,000 units per month

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 Illustration 1
A company makes a single product with a sales price of GH¢10
and a marginal cost of GH¢6. Fixed cost are GH¢60,000 per
annum. Calculate the following:
a. Number of units to break-even
b. Sales at break-even point
c. Contribution/Sales Ratio
d. The number of units to be sold to achieve a target profit of
GH¢20,000
e. The level of sales to achieve a profit of GH¢20,000 per annum
f. The number of units required to maintain a profit of GH
¢20,000 if marginal cost increases to GH¢6.5 and fixed cost
increased to GH¢70,000 but selling price remains the same.
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 Solution
a. Break-even Point (units) = Fixed Cost
Contribution per unit
= GH¢60,000
GH¢10 – GH¢6
= 15,000 units

b. Break-even Point (Sales) = Fixed cost X Selling Price per Unit

Contribution per unit
= GH¢60,000 X GH¢10
GH¢10 – GH¢6
= GH¢150,000

c. Contribution/Sales Ratio = Contribution per unit X 100

Selling Price per unit
= GH¢4 X 100
GH¢10
= 40%

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 Solution
d. Level of Sales to result in target profit (units) = Fixed cost + target profit
Contribution per unit
= GH¢60,000 + GH¢20,000
GH¢4
= 20,000 units
e. Level of Sales to result in target profit (sales)
= Fixed Cost + target profit x SP per unit
Contribution per unit

= GH¢60,000 + GH¢20,000 x 10
GH¢4
= GH¢200,000

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 Solution
f. Level of Sales to result in target profit (units)
= Fixed cost + target profit
Contribution per unit
= GH¢70,000 + GH¢20,000
GH¢10 - GH¢6.5
= 25,714 units

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 MARGIN OF SAFETY
The Margin of Safety is a measure of by how much actual
sales can fall short of the budgeted sales volume without
a loss being incurred.
It is the difference between the expected level of sales
and the breakeven point.
The larger the margin of safety, the more likely it is that a
profit will be made, that is, if sales start to fall, there is
more leeway before the organization begins to incur
losses.
In the illustration 1, if forecast sales are 27,000 units per
month, the margin of safety can be easily calculated as
follows:
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 Margin of Safety (cont’d)

Margin of Safety (units) = Projected sales – BEP (units)

= 27,000 units – 15,000 units
= 12,000 units

Margin of Safety (%) = Margin of safety (units) X 100

Projected Sales
= 12,000 X 100
27,000
= 44.4%

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 THE CONTRIBUTION TO SALES (C/S) RATIO
As discussed earlier, the contribution to sales
ratio (C/S ratio) is a measure of the percentage
of contribution compared to sales
A higher C/S ratio means the contribution
grows more quickly as sales increase
It is sometimes referred to as Profit-Volume
ratio
It can be used to determine the break-even
point as follows:

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 THE CONTRIBUTION TO SALES (C/S) RATIO
Using the data from Illustration 1
Break-even point (sales) = Fixed Cost
C/S Ratio
= GH¢60,000
40%
= GH¢150,000

Break-even point (units) = BEP (sales)

SP/unit
= GH¢150,000
GH¢10
= 15,000 units
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 Trial Question
A company manufactures a single product which has the following cost and selling
price structure per unit:
GH¢ GH¢
Selling Price120
Direct Material 22
Direct Labour 36
Variable overheads 14
Fixed overhead 12 84
Profit 36
The fixed overhead absorption rate is based on a normal capacity of 2000 units per
month. Assume that the same amount is spent each month on fixed overheads.
Budgeted sales for next month are 2,200 units
You are required to calculate:
a) the breakeven point, in sales units per month;
b) the margin of safety for next month;
c) the budgeted profit for next month;
d) the sales required to achieve a profit of GHS96,000 in a month.

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