COST-VOLUME-PROFIT ANALYSIS

COST-VOLUME-PROFIT ANALYSIS
Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume affect a company's operating income and net income. In performing this analysis, there are several assumptions made, including: Sales price per unit is constant. Variable costs per unit are constant. Total fixed costs are constant. Everything produced is sold. Costs are only affected because activity changes. If a company sells more than one product, they are sold in the same mix.

Cost-volume-profit analysis (CVP), or break-even analysis, is used to compute the volume level at which total revenues are equal to total costs. When total costs and total revenues are equal, the business organization is said to be "breaking even." Total cost = Total fixed cost + Total variable cost There are a number of costs that vary or change, but if the variation is not due to volume changes, it is not considered to be a variable cost. Examples of variable costs are direct materials and direct labor. Total fixed costs do not vary as volume levels change within the relevant range. Examples of fixed costs are straight-line depreciation and annual insurance charges.

CONTRIBUTION AND P/V RATIO

Key calculations when using CVP analysis are the contribution margin and the profit volume ratio. The contribution margin represents the amount of income or profit the company made before deducting its fixed costs. Said another way, it is the amount of sales available to cover (or contribute to) fixed costs. The contribution margin is sales revenue minus all variable costs. It may be calculated using rupees or on a per unit basis.

CONTRIBUTION
Sales-variable cost Fixed cost + profit Fixed cost loss (Sales at BEP in Rs. * PV ratio) + Profit (Sales at BEP in units * Contribution /unit) + Profit (Margin of safety in Rs.*P/V ratio)+ fixed cost (Margin of safety in units * Contribution /unit) + fixed cost Profit/ Margin of safety in %

Profit Volume (P/V) RATIO

Contribution/Sales*100

Change in profit/Change in sales*100

Fixed cost/B.E.P. in Rs.*100

Profit/Margin of Safety in Rs.*100

100-Variable cost as a % of sales

BREAK EVEN POINT

The break-even point represents the level of sales where net income equals zero. In other words, the point where sales revenue equals total variable costs plus total fixed costs, and contribution margin equals fixed costs. Break-even point in rupees
BREAK EVEN SALES = FIXED COST / PV RATIO

Break-even point in units

BREAK EVEN POINT = FIXED COST / CONTRIBUTION PER UNIT BEP= Actual sales-Margin of safety

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, also called targeted 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 dollars, or the total is divided by contribution margin per unit to determine the required sales level in units.
REQUIRED SALES IN RUPEES (FIXED COST + DESIRED PROFIT)/PROFIT VOLUME RATIO REQUIRED SALES IN UNITS (FIXED COST + DESIRED PROFIT)/CONTRIBUTION PER UNIT

MARGIN OF SAFETY
Margin of safety is the difference between the expected (or actual) sales level and the breakeven sales level. Margin of safety represents the strength of the business. It enables a business to know what is the exact amount it has gained or lost and whether they are over or below the break even point. It can be expressed in the equation form as follows: Margin of Safety Expected (or) Actual Sales Level (quantity or rupee amount) - Breakeven Sales Level (quantity or rupee amount)

MOS as % of sales= MOS/Actual Sales*100 MOS= Profit/PV Ratio MOS= 100- BEP in % Profit= MOS * PV Ratio Profit= Actual sales*MOS Ratio*PV Ratio

Profit
Sales- Total cost Sales-variable cost-fixed cost Contribution-fixed cost MOS in Rs.* PV ratio

Fixed Cost
Sales - Variable cost - profit Sales - Variable cost + loss Contribution-Profit Contribution + Loss Total cost Variable cost Sales at BEP in Rs. * PV ratio

Utility of CVP Analysis

Fixation of Selling Price: The cost of the product and the desired profitability are two important factors which govern the fixation of selling price.

Maintaining a desired level of profit: In the face of price cuts, in case the demand for the companys product is elastic, the minimum level of profit can be maintained by pushing up the sales. The volume of such sales can be found out by the marginal costing technique.

Accepting of price less than total cost: Sometimes prices have to be fixed below the total cost of the product. In such a scenario, a price less than the total cost but above the marginal cost may be acceptable because in such periods any material contribution towards recovery of fixed costs is acceptable rather than no contribution at all. Decisions involving alternative choices: The technique of marginal costing helps in making decisions involving alternative choices ex. Discontinuance of a product line, changes of sales mix, make or buy, own or lease, expand or contract etc. The technique used is differential costing, which is an extension of the technique of marginal costing.

1. From the following information calculate: (i) P/V Ratio (ii) Fixed cost (iii) sales volume to earn a profit of Rs.40,000. Given: i. Sales: Rs.1,00,000 ii. Variable cost : 70% of sales iii. Profit : Rs.10,000. 2. In a period sales amount to Rs.2,00,000 and net profit Rs.20,000. Fixed overheads are Rs.30000. Find out: (i) P/V Ratio (ii) Profit when sales will be Rs.3,00,000 (iii) Sales to earn a profit of Rs.30,000 (iv) Contribution when sales will be Rs.1,50,000 (v) Variable cost for sales of Rs.3,00,000

3. From the following information, calculate: (i) P/V Ratio (ii) B.E.P. (iii) M.O.S. Total Sales Rs.3,60,000 Selling price per unit Rs.100 Variable Cost per unit Rs.50 Fixed Cost Rs.1,00,000

4. Three Firms X, Y, Z manufacture the same product. The selling price is Rs.8 per unit. The fixed costs for firms are Rs.80000, Rs.2,00,000 and Rs.3,30,000 respectively, while variable cost per unit is Rs.6, Rs.4 and Rs.3. Determine B.E.P. for all the firms. How much profit will be earned if each firm sells 80,000 units?

5. You are given the following information: Period Sales Profit (+) Loss(-) August 2004 90,000 -10,000 September 2004 1,30,000 +10,000 Calculate: (a) P/V Ratio (b) Fixed Overhead (c) Level of activity if profit is 25000. (d) Expected profit if sales is Rs.180000 (e) B.E.P. 6. A company gives you following information about its product: Year Sales Profit 2003 15000 400 2004 19000 1150 Calculate: (a) P/V Ratio (b) Level of activity if profit is 2000. (c) Expected profit / loss if sales is Rs.12000 (d) B.E.P.

7. The statement of profit of XYZ Ltd. are as under: Particulars Rs. Sales (16000 units) 3,20,000 Less: Variable cost (Rs.15 per unit) 2,40,000 Contribution 80,000 Less: Fixed cost 60,000 Profit 20,000 Calculate P/V Ratio and then on the basis of P/V Ratio, Determine: Sales for 40% P/V Ratio. Break even point Contribution when sales amount to Rs.2,56,000. MOS when profit is Rs.4,000. Variable cost when sales amounts to be Rs.2,56,000. If the selling price per unit is reduced to Rs.16, the new sales volume to offset this price reduction. Sales to earn a profit of Rs.40,000.

8. The budgeted result for XYZ Ltd. include the following: Product Sales Variable cost as % of sales A 50,000 60% B 40,000 50% C 80,000 65% D 30,000 80% E 44,000 75% Fixed overhead for the period are Rs.90,000. Produce a statement showing the amount of profit / loss expected. Suggest a change in the sales volume of each product which will result in a profit of Rs.50,000, assuming that the sales of only one product can be increases at a time.

9. A firms sale for the month of March was Rs.4,00,000 and it made a profit of Rs.40,000. For the month of April sales were Rs.500000 and profit is increased to Rs.60,000. Determine: (a) Variable cost as % of price (b) Fixed cost (c) B.E.P. (d) Amount of sales if desired profit is Rs.80,000.

10. Total cost of a firm at monthly sale of 59,000 units was Rs.2,28,000, while that at 63,000 units under the same condition would have been Rs.2,36,000. Sale proceeds for 59,000 units were Rs.2,36,000. (a) At what level of sales per month will the profit be zero. (b) If the firm wants to earn a profit of Rs.40,000, what changes will be necessary in the following, each taken separately: (i) unit sold (ii) selling price per unit (iii) non-variable exp (iv) variable cost per unit (c) How will present profit be affected if the firm: (i) Decreases selling price by 5%. (ii) Reduces variable cost by 5%. (iii) Increases volume of sale by 10% and increases nonvariable cost by 2% - Both taken together.