COST VOLUME PROFIT

ANALYSIS (CVP
ANALYSIS)
INTRODUCTION
 COST VOLUME PROFIT ANALYSIS
(CVP ANALYSIS) / BREAK -EVEN
ANALYSIS
 Is a technique which studies the relationship between cost, volume and profit
at different levels of operations
 The Cost-Volume-Profit (CVP) analysis helps management in finding out the

relationship of costs and revenues to profit. The aim of an undertaking is to

earn profit. Profit depends upon a large number of factors, the most important
of which are the costs of the manufacturer and the volume of sales effected.
CVP analysis assumptions:
 All cost can be separated into fixed and variable.

 Fixed cost remains constant.

 Variable cost per unit remains constant.

 Selling price of a product remains constant.

 There is only one product or constant product mix

 The entire production will be sold.

 The only factor affecting cost and revenue is volume, that is quantity

 Profits are calculated in variable cost bases

 OBJECTIVES OF COST-VOLUME-PROFIT
ANALYSIS
 The objectives of cost-volume-profit analysis are given below:
 In order to forecast profit accurately, it is essential to know the relationship
between profits and costs on the one hand and volume on the other.
 Cost-volume-profit analysis is useful in setting up flexible budgets which indicate
costs at various levels of activity.
 Cost-volume-profit analysis is of assistance in performance evaluation for the
purpose of control. For reviewing profits achieved and costs incurred, the effects on
cost of changes in volume are required to be evaluated.
 Pricing plays an important part in stabilizing and fixing up volume. Analysis of
cost-volumeprofit relationship may assist in formulating price policies to suit
particular circumstances by projecting the effect which different price structures have
on costs and profits.
 As predetermined overhead rates are related to a selected volume of production,
study of cost-volume relationship is necessary in order to know the amount of
overhead costs which could be charged to product costs at various levels of
operation.
BREAK EVEN POINT (BEP)
 Break-even analysis examines the relationship between the
total revenue, total costs and total profits of the firm at
various levels of output.
 It is used to determine the sales volume required for the
firm to break-even and the total profits and losses at other
sales level.
 The breakeven point is the quantity of output sold at which
total revenues equal total costs. There is neither a profit nor
a loss at the breakeven point.
 BEP in Units =
 BEP in Shilling = BEP units x Selling Price
EXAMPLE
 Assume a company sells 2,000 units of its only product
for TZS 50 per unit, variable cost is TZS 20 per unit,
and fixed costs are TZS 60,000 per month. Given these
conditions, the company is operating at the breakeven
point:
TZS
Revenue = (2,000 units x 50/-) 100,000
Deduct: Variable cost (2000 units x 20/-) 40,000
Fixed cost 60,000
Profit 00
CONTRIBUTION MARGIN (CM) AND
CONTRIBUTION MARGIN RATIO (CMR)

 The contribution margin represents the amount of

income or profit the company made before
deducting its fixed costs.
 When calculated as a ratio, it is the percent of sales
shilling available to cover fixed costs.
 CM = Sales – Variable cost
 CMR = CM/Sales
PROFIT-VOLUME (P/V) RATIO
 The Profit Volume (P/V) Ratio is the measurement of the rate
of change of profit due to change in volume of sales. It is one
of the important ratios for computing profitability as it
indicates contribution earned with respect of sales.
 The PV ratio or P/V ratio is arrived by using following
formula.
 P/V ratio =contribution Margin /sales *100
 Here contribution is multiplied by 100 to arrive the percentage.
 For example, the sale price of a cup is TZS.80, its variable cost
is TZS.60, then PV ratio is (80-60)/80 * 100 = 25%
 From the above example, we may observe that the variable cost
is the important cost in deciding profitability when fixed costs
are constant
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.
 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
amount, or the total is divided by contribution margin per
unit to determine the required sales level in units.
 Required sales in shilling =

 Required sales in unit =

MARGINAL OF SAFETY (MS)
 The margin of safety is the difference between the amount of
expected profitability and the break-even point. The margin of
safety formula is equal to current sales minus the breakeven
point, divided by current sales.
 The margin of safety is a financial ratio that measures the amount
of sales that exceed the Breakeven Point. In other words, this is
the revenue earned after the company or department pays all of
its fixed and variable costs associated with producing the goods
or services.


 Marginal of safety = Actual sales – Breakeven sales

 Marginal of safety ratio = MS/Sales x 100
EXAMPLE
Tokio Ltd manufactures and sells only one product. The product is sold at TZS 10 per unit. Other
details are as follows:
 Variable cost per unit TZS 5
 Fixed cost per month TZS 20,000
 Normal sales per month 6,000 units
Required:
1. Calculate the contribution per unit.
2. Calculate the contribution ratio (P/V ratio).
3. Calculate the break-even point in units.
4. Calculate the break-even point in sales value .
5. Calculate the margin of safety and the margin of safety ratio.
6. Calculate the net profit per month if 5000 units are sold.
7. Suppose the variable cost increases to TZS 6 per unit and the fixed cost decreases to TZS 18,000.
7.1. Calculate how many more units have to be sold in order to break-even.
7.2. Calculate the number of units to be sold in order to earn a net profit of TZS 7,500 per month.
EXAMPLE
 A store sells t-shirts. The average selling price is TZS15 and the
average variable cost (cost price) is TZS9.
 Required:
1. Suppose the fixed costs of operating the store (its operating
expenses) are TZS 100,000 per year. Find Break-even in units?
2. If the owner desired a profit of TZS 25,000, what will be break-
even point in shilling?
3. If fixed costs rose to TZS110,000, break-even in units volume
would be?
4. If the average selling price rose to TZS16, break even volume
would fall?
CVP ANALYSIS: MULTI - PRODUCTS

 In today’s complex production times no company

produces a single product only.
 Often companies produce and sell more than one
product.
 Breakeven analysis under these circumstances is
somewhat more complex than discussed earlier in this
chapter. The reason is that different products will have
different selling prices, different costs, and different
contribution margins. Consequently the breakeven point
will depend on the mix in which the different products
are sold.
CVP ANALYSIS: MULTI -
PRODUCTS
 Businesses try to achieve the combination (or mix)
that will yield the greatest amount of profits. Most
companies produce several products and often
these products are not equally profitable.
 this is true, profits will depend to some extent on
the company’s sales mix. Profits will be greater if
high-margin rather than low-margin items make up
a relatively large proportion of total sales
CVP ANALYSIS: MULTI -
PRODUCTS
 Changes in sales mix can cause interesting variations in
a company’s profits. A shift in the sales mix from high
margin items to low margin items can cause total profits
to decrease even though total sales may increase.
 Conversely, a shift in the sales mix from low margin
items to high margin items can cause total profits to
increase even though total sales may decrease. It is one
thing to achieve a particular sales volume; it is quite a
different thing to sell the most profitable mix of
products!
BREAK-EVEN POINT IN UNITS
 You will recall from the previous paragraphs above
that the break-even point in units is calculated as
follows:
Break-even point in units =
 When there is more than one product, the formula

is adjusted as follows;
 Break-even point in units =
EXAMPLE
 Hangana Ltd supplied the following information
regarding its three products
Product A Product B Product C
Sales in units 2000 3000 5000
Selling price per unit 20/- 50/- 40/-
Variable cost per unit 16/- 36/- 28/-
Total fixed cost TZS 77,000

Required
Compute company’s break even point in unit
INDIVIDUAL BREAK EVEN
POINT
 In Example above the break-even point was 7000 units
for all three products combined. However, production
planning and scheduling require break-even data for
individual products.
 The sales mix used to calculate the weighted average
contribution per unit is now used to extract the
individual product break-even points.
 Total break-even units are multiplied by the individual
sales mix percentages to determine the break-even point
for individual products. The calculation is as follows:
BREAK-EVEN POINT IN SALES
VALUE
 In the previous paragraphs above you learned that the
break-even point in sales value could be determined in two
different ways:
 Break-even point in sales value = Break-even point in units

x Selling price per unit

OR
 Break-even point in sales value = Total fixed
cost/Contribution ratio
 In a multi-product situation, the break-even point in sales

value can also be calculated in two different ways by

adjusting these two formulas.
BREAK-EVEN POINT IN SALES VALUE

 By using the weighted average selling price per unit

One way of calculating the break-even point in sales value is to
compute the weighted average selling price per unit and then
applying the following formula:
Break-even sales value = Break-even quantity x Weighted average selling price
per unit
 By using the average contribution ratio
 If the average contribution ratio is known, the break-even point

in sales value can be computed by means of the following

formula:
Break-even point in sales value = Total fixed costs/Average
contribution ratio
EXAMPLE
 Refer to the example above
Required:
Calculate the break-even point in sales value
i. Weighted average selling price per unit
ii. Average contribution ratio.
COST STRUCTURE AND THE OPERATING
LEVERAGE FACTOR (SENSITIVITY
ANALYSIS)
 The concept cost structure refers to the relative relationship between fixed
and variable costs in an enterprise. During recent years the cost structure
of manufacturing enterprises has changed in that costs have become more
fixed as a result of automation. More machines and less manual labour are
used in production.
 Enterprises with a high percentage fixed costs are more sensitive to
changes in sales than enterprises with a low percentage fixed costs.
 For example, consider a firm with relatively high fixed costs (ie, relatively
low variable costs and consequently a high profit-volume ratio). If sales
should increase, profit will increase as a higher rate than for a firm with
relatively low fixed costs, because of the high profit-volume ratio.
However, if sales should drop, profit will also drop at a higher rate
because, although variable costs will drop as well, the fixed costs (rent,
salaries, etc) must still be paid
EXAMPLE
 The following details regarding two different firms are available:

COMPANY A COMPANY B
TZS % TZS %
Sales 60,000 100 60,000 100
Less: Variable cost 15,000 25 30,000 50
Contribution 45,000 75 30,000 50
Less: Fixed cost 30,000 15,000
Net profit 15,000 15,000

Required:
i. Calculate the increase in profit for each company if sales were to increase
by 20%.
ii. Calculate the decrease in profit for each company if sales were to decrease
by 20%.
OPERATING LEVERAGE
FACTOR
 The operating leverage factor reflects how much influence
a percentage change in sales volume has on net profit.
 A specific operating leverage factor is valid for a specific
sales volume and changes as the sales volume changes.
 The operating leverage factor is calculated as follows:
 Operating Leverage Factor =
 The operating leverage is a management instrument that
shows, relatively easily, the effect of a change in turnover on
net income, without detailed statements having to be prepared
EXAMPLE
 The management of Shilongo Ltd supplied the following
details:
TZS
Sales 100,000
Variable cost 20,000
Fixed cost 40,000
Required:
 Calculate the operating leverage factor

 Use the operating leverage factor calculated above to compute

the increase in net income if sales were to increase by 15%.

THANK YOU FOR YOUR
TIME AND ATTANTION
NEXT CHAPTER: INCOME EFFECTS OF ALTERNATIVE
COST ACCUMULATION SYSTEMS