Cost-Volume-Profit Analysis

The main objective of an organization is

to earn profit and profit depends on 3
(three) basic factors. These are:

Cost of production
Selling prices
Volume of sales

Cost-Volume-Profit Analysis
These three factors are inter dependent
because selling price depends to a
certain extent on cost if a desired profit
is to be obtained and volume of
depends upon volume of production,
which in turn is related to costs. For
budgeting and profit planning the
management
should
have
an
understanding of the inter relationship
between these factors.

Cost-Volume-Profit Analysis
Cost Volume-Profit (CVP) analysis helps
managers understand this relationship by
focusing on interactions among five
elements. These are:
Selling price
Volume of sales or level of
activity
Product mix of sales
Variable costs per unit
Total fixed costs

Break-even Analysis
The study of cost-volume-profit analysis is
often referred to as break-even analysis but
there are some fundamental differences
between them. The term break even analysis
is used in narrow as well as broad sense. In
its narrow sense, break-even analysis is
concerned with finding out the level of activity
or volume of sales where total revenue is
equal to total costs i.e. the break-even point.
In a broad sense, it refers to the analysis of
relationship between cost, volume and profit
at different levels of sales or production.

Underlying Assumptions of Breakeven Analysis

The break-even analysis is based on the
following assumptions:

All costs are divided into fixed & variable.

Total fixed costs remain constant.
Variable cost per unit remains constant.
Selling prices are to be unchanged.
All units produced are sold.
There is only one product or in case of multiple.
products the sales mix will remain constant.
Efficiency and productivity do not change.

Approaches/Techniques for Break

even Point Calculation
Break even point is a point or level of sales at which
revenues are equal to expenses.
That is at this point there is no profit or loss.
Break even point can be computed using either

Contribution Margin Technique/Approach

or
Equation Technique/Approach
Contribution Margin (CM) is the excess of selling
price over the variable cost per unit.

Contribution Margin
Technique
Contribution Margin (CM) is the excess of
selling price over the variable expenses

The break-even point can be defined either as:

The point where total sales revenue equals total
expenses (variable and fixed).
The point where total contribution margin equals
total fixed expenses.

Contribution Margin
Technique
Example: Suppose a company sells

500
speakers @ Tk. 500 each per month.
The
variable cost per unit is Tk. 300 and fixed cost
are Tk. 80,000.

Sales (500 speakers)

Less Variable expenses
Contribution margin
Less Fixed expenses
Net operating income

Total
Tk. 250,000
150,000
100,000
80,000
Tk. 20,000

Per Unit
Tk. 500
300
Tk.200

If the contribution margin is not sufficient to cover the fixed

costs, then a loss occurs for the period.

Contribution Margin
Technique
To illustrate with an extreme example,
assume that by the middle of a
particular month the company has
been able to sell only 1 speaker. If the
company does not sell any more
speaker during the month, the
companys income statement will
appear as you see in the next slide.

Contribution Margin
Technique

Total Per Unit

Sales (1 speaker)
Less Variable expenses
Contribution margin
Less Fixed expenses
Net loss

Tk. 500
300

Tk. 500
300

200

Tk.200

80,000
Tk. 79,800

Each speaker sold yields Tk. 200 in contribution

margin. So, to reach the break even point i,e; to
cover the fixed expenses of Tk. 80,000, the company
will have to sell 400 speakers in a month.

Contribution Margin
Technique
Total
Tk. 200,000

Per Unit
Tk. 500

Less Variable expenses

120,000

300

Contribution margin
Less Fixed expenses
Net operating income

80,000
80,000
Tk. 0

Tk.200

Sales (400 speakers)

If the company sells 400 speakers in a

month, it will be operating at the breakeven point.

Equation Technique
The equation technique is the most general form
of analysis where the income statement can be
expressed in equation form or as a mathematical
model as you see in the television screen.
[

Sales revenue Variable expenses Fixed expenses = Profit

Unit
Sales
sales volume
price in units

Sales
Unit
variable volume
expense in units

(Tk. 500 N) (Tk. 300 N) Tk. 80,000 = Tk. 0

Equation Technique
The break-even point in unit sales, N, can be Computed
as follows:

Sales revenue = Variable expenses Fixed expenses + Profit

Tk. 500 N= Tk. 300 N + Tk. 80,000 + Tk. 0

Tk. 500 N- Tk. 300 N = Tk. 80,000 + Tk. 0
Tk. 200 N= Tk. 80,000 Where
N= No. of speakers sold
N= 80,000/200
Tk. 500= Unit sales price
Tk. 3000= Unit variable expense
..N= 400 speakers
Therefore, BEP (units)=

Fixed Expense
Unit Contribution Margin

Equation Technique
The break-even point in sales taka, S, can be
Computed as follows:

Sales revenue = Variable expenses Fixed expenses + Profit

Tk. S= Tk. 0.60 S + Tk. 80,000 + Tk. 0

Tk. S- 0.60S = Tk. 80,000 + Tk. 0
Tk. 0.40S= Tk. 80,000 Where
S= Sales Tk.
S= 80,000/0.40
Tk. .60= VE as a % of sales
S= Tk. 200,000
Therefore, BEP (Tk.)=

Fixed Expense
Contribution Margin Ratio

Contribution Margin Ratio

Contribution Margin Ratio=

Contribution Margin
Sales

For the company, the contribution margin

ratio is:
Tk.200
= 40%
Tk. 500

Profit= CM Ratio Sales - Fixed Expenses

Cost-Volume-Profit Graph

Sales in Taka

Break-even
point

Total expenses

ss
o
L

a
e
r
a

Total sales

Pro

rea
a
fit

Variable expenses
Fixed expenses

Volume in speakers sold (units)

Target Net Profit

We can determine the number of
speakers that the company must sell
to earn a profit of Tk. 100,000 using
the contribution margin approach.

Fixed expenses + Target profit

Unit contribution margin

Units sold to earn

the target profit

Tk.80,000+Tk.100,000
= 900 speakers
Tk. 200

Applying CVP Analysis

Safety Margin
The difference between budgeted sales
revenue and break-even sales revenue.
The amount by which sales can drop
before losses begin to be incurred.
M/S=Tk. 250,000-Tk. 200,000=Tk. 50,000