Institute of Certified General Accountants of Bangladesh (ICGAB)

Performance management (P13)

LC-3: CVP Analysis

CVP (Cost, volume & Profit) Analysis:

CVP analysis is a method of cost accounting that looks at the impact that varying levels of costs
and volume have on operating profit. The cost-volume-profit analysis, also commonly known as
break-even analysis, looks to determine the break-even point for different sales volumes and cost
structures, which can be useful for managers making short-term economic decisions.

Single product break-even analysis:

The breakeven point is the level of activity at which there is neither profit, nor loss.

Finding the breakeven point is simple. In the following illustration, each unit sells for $200 and
contributes $160 towards covering fixed costs of $600,000:

Particulars Amount in $
Selling price per unit 200
Less: Variable cost per unit 40
Contribution per unit 160
Total fixed costs 600,000
Profit ?

In order to breakeven, we need to cover our fixed costs. Here, the breakeven point = Total fixed
costs divided by the unit contribution: $600,000/$160 = 3,750 units.

Example:

The following data relate to Product PQ:

Particulars Amount in $
Selling price per unit 25
Variable cost per unit 20

Fixed costs are $50,000.

A. Calculate the number of units that must be made and sold in order to break even.
Breakeven point in units = Fixed cost / Contribution per unit

B. Calculate the level of activity that is required to generate a profit of $40,000.

Level of activity to earn a required profit = required profit + fixed cost / Contribution per unit

Md. Mokhlesur Rahman, FCMA

 C. The company budgets to sell 13,000 units of Product PQ. Calculate the margin of safety:
The margin of safety is the difference between the budgeted level of activity and the break-
even level of activity. It may be expressed in terms of units, sales value or as a percentage
of the original budget.

D. Calculate the contribution/sales ratio for Product PQ:

The C/S ratio is normally expressed as a percentage. It is constant at all levels of activity. The
C/S ratio reveals the amount of contribution that is earned for every $1 worth of sales revenue.

C/S Ratio = Contribution / Sales

E. Calculate the breakeven point again, this time expressed in terms of sales revenue.
Breakeven point in sales revenue = Fixed cost / C/S Ratio

F. Calculate the sales revenue that is required to generate a profit of $40,000.

Sales revenue to earn a required profit = Required profit + Fixed costs / C/S ratio

Drawing a basic breakeven chart: Follow page number 80.

Example 2:

A company manufactures Product RS. The following data are available:

Selling price: $100 per unit

Variable cost: $60 per unit.

Fixed costs are $250,000.

The company budgets to produce 12,000 units in the next period. Required:

(a)Scenario I –Calculate:

(i)The breakeven point (expressed in units and $ of revenue).

(ii)The level of activity required to generate a profit of $90,000 (expressed in units).
(iii)The margin of safety as a percentage.

(b)Using graph paper, draw a profit-volume chart for scenario I.

Md. Mokhlesur Rahman, FCMA

(c)Scenario II –Using the graph drawn in (b), illustrate and explain the impact of a change in selling
price to $120 per unit, on:

(i)The breakeven point (expressed in units and $ of revenue)

(ii)The level of activity required to generate a profit of $90,000 (expressed in units)
(iii)The margin of safety

Solution:

(a)Scenario I
i.
Contribution per unit = 100-60 $ 40 per unit
BEP (units) =$250,000 ÷ $40 =6,250 units
C/S ratio =$40/$100 =0.40
BEP ($ revenue) =$250,000 ÷ 0.40 =$625,000

(ii)Level of activity = ($90,000 + $250,000) ÷ $40 = 8,500 units

Level of activity = ($90,000 + $250,000) ÷ 0.40 = $850,000

(iii)Margin of safety =12,000 –6,250 = 5,750 units

Or expressed in $Revenue = $575,000.

Margin of safety expressed as a % of the budget: 5,750 units/12,000 units = 48% approx.

Answer to the question number b: see the page no. 101

(c)Scenario II

(i)Contribution per unit=$120 –$60=$60 per unit

BEP (units)=$250,000 ÷$60=4,167 units
C/S ratio=$60/$120=0.50

Explain: Graphically, point I (Fixed costs) remains the same at $(250,000), but RS would
breakeven earlier at 4,167 units instead of 6,250 units. The profit line gradient steepens. This is
because a higher selling price increased contribution per unit and fixed costs are recovered quicker.

BEP ($ revenue) = $250,000 ÷ 0.50 = $500,000

(ii)New CS ratio= $60/$120=0.50

Target revenue=($90,000 + $250,000) ÷ 0.50 = $680,000 or 5667 units

'Explain: Graphically, point I (Fixed costs) remains the same at $(250,000), but RS would
breakeven earlier at 4,167 units instead of 6,250 units. The profit line gradient steepens. This is
because a higher selling price increases contribution per unit, and fixed costs are recovered quicker.

Md. Mokhlesur Rahman, FCMA

The level of activity/number of units sold required to achieve a profit of $90,000 is therefore lower
than in Scenario I.

(iii)Margin of safety=12,000 –4,166=7,834 units

7,834 units ÷ budgeted 12,000 units =65% approx.
Explain: An increased contribution impacts favorably on the margin of safety. Sales need to fall
65% short of budget before RS starts making a loss –compared with 48% in scenario I.

Example 3:
Murray Ltd produces and sells two types of sports equipment items for children, balls (in batches)
and miniature racquets.

A batch of balls sells for $8 and has a variable cost of $5. Racquets sell for $4 per unit and have a
unit variable cost of $2.60.

For every 2 batches of balls sold, one racquet is sold. Murray budgeted fixed costs are $407,000
per period. Budgeted sales revenue for next period is $1,250,000 in the standard mix.

To calculate the margin of safety.

Step 1 –Calculate contribution per unit:

Particulars Balls $ per batch Racquets $ per unit

Sales price 8 4
Less: Variable cost 5 2.6
Contribution 3 1.4

Step 2 –Calculate contribution per mix:

($3 × 2 batches) + ($1.40 × 1 racquet) =$7.40

Step 3 –Calculate the breakeven point in terms of the number of mixes:

Breakeven point = Fixed costs/Contribution per mix = $407,000/$7.40 = 55,000 mixes

Step 4 –Calculate the breakeven point in terms of the units of the products:

55,000 mixes × 2 = 110,000 balls

55,000 mixes × 1 = 55,000 racquets

Step 5 –Calculate the breakeven point in terms of revenue

($8 × 110,000 batches) + ($4 × 55,000 racquets) =$1,100,000

Md. Mokhlesur Rahman, FCMA

Step 6 –Calculate the margin of safety:

Budgeted sales – breakeven sales = $1,250,000 –$1,100,000 = $150,000

Or, as a percentage, ($1,250,000 – $1,100,000) / $1,250,000 = 12%

Limitations of breakeven analysis:

The following underlying assumptions will limit the precision and reliability of a given cost--
volume-profit analysis.

(1)The behavior of total cost and total revenue has been reliably determined and is linear over the
relevant range.
(2)All costs can be divided into fixed and variable elements.
(3)Total fixed costs remain constant over the relevant volume range of the CVP analysis.
(4)Total variable costs are directly proportional to volume over the relevant range.
(5)Selling prices are to be unchanged.
(6)Prices of the factors of production are to be unchanged (for example, material, prices, wage
rates)
(7)Efficiency and productivity are to be unchanged.
(8)The analysis either covers a single product or assumes that a given sales mix will be maintained
as total volume changes.
(9)Revenue and costs are being compared on a single activity basis (for example, units produced
and sold or sales value of production).

Example 4.

PER plc sells three products. The budgeted fixed cost for the period is £648,000. The budgeted
contribution to sales ratio (C/S ratio) and sales mix are as follows:

Product C/S Ratio (%) Mix (%)

P 27 30
E 56 20
R 38 50

Required:
What is the breakeven sales revenue?

Solution:
Breakeven point in $= Fixed Cost / C/S ratio of the mix

C/S ratio of the mix = (0.3*27%) + (0.2*56%) + (0.5*38%) = 38.3%

Therefore, BEP = $648,000 / 38.3% = $1,691,906

Md. Mokhlesur Rahman, FCMA