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Cost-Volume-Profit Analysis

Prepared by:-
Ashish goyal
Ashish pandey
Brijesh gupta
Divy asthana
Cost-Volume-Profit Analysis

• Examines the behaviour of total revenues, total costs,


and operating income as changes occur in the output
level, selling price, variable costs or fixed costs
Assumptions of CVP Analysis
1. revenues change in relation to production and sales
2. costs can be divided in variable and fixed categories
3. revenues and costs behave in a linear fashion
4. costs and prices are known
5. if more than one product exists, the sales mix is constant
6. we can ignore the time value of money
Contribution Margin
• Contribution margin is equal to the difference between
total revenue and total variable costs
Contribution margin per unit
= Selling price - Variable cost per unit
Contribution margin percentage
= Contribution margin per unit / selling price per unit
Total for
Per Unit 2 units %

Revenue $200 $400 100%


Variable costs120 240 60%
Contribution margin $80 $160 40%
Contribution Margin Income Statement
• Income statement that groups line items by cost
behaviour to highlight the contribution margin

Packages Sold
0 1 2 25 40
Revenue $0 $200 $400 $5,000 $8,000
Variable costs 0 120 240 3,000 4,800
Contribution margin 0 80 160 2,000 3,200
Fixed costs 2,000 2,000 2,000 2,000 2,000
Operating income $(2,000) $(1,920) $(1,840) $0 $1,200
Breakeven Point
• Quantity of output where total revenues equal total costs
• Point where operating income equals zero

Breakeven point in units


= Fixed costs / Contribution margin per unit
= $2,000 / $80
= 25 units

Breakeven point in dollars


= Fixed costs / contribution margin %
= $2,000 / 40%
= $5,000
Cost-Volume-Profit Graph
Breakeven Total revenues
$10,000 line
Point
25 units
$8,000 Total costs
line
$6,000
Operating
$4,000 income

$2,000
Operating
$0 loss

0 10 20 30 40 50
Units Sold
Target Operating Income

• For most firms in the private sector, the main objective is not
to breakeven
• Convert after-tax desired net income to its before-tax
equivalent operating income
Target operating income
= Target net income / (1 - tax rate)
Target Unit Sales
= (Fixed costs + Target operating income)
/ Contribution margin per unit
Target Dollar Sales
= (Fixed costs + Target operating income)
/ Contribution margin %
Sensitivity Analysis

• sensitivity analysis is a “what-if” technique that


examines how a result will change if the original
predicted data are not achieved or if an underlying
assumption changes
• What will happen to operating income if volume
declines by 5%?
• What will happen to operating income if variable costs
increase by 10% per unit?
• sensitivity analysis broadens management’s
perspectives about possible outcomes
Alternative Cost Structures

• CVP helps managers assess the risks and potential benefits of


adopting alternative cost structures
Example: Alternative rental arrangements
Option 2
Option 1 $1,400 Fixed Fee Option 3
$2,000 Fixed Fee + 5% Commission 20% Commission

Rev Rev Rev


$ $ $
Cost Cost Cost

Units Units Units


Breakeven = 25 units Breakeven = 20 units Breakeven = 0 units
Revenue Mix

• Revenue mix (or sales mix) is the relative combination of


quantities of products or services that make up total
revenue

Do-All Do-All Superword

• Sales mix of Do-All : Superword = 2 : 1

Breakeven point in units


= 30 units 20 units of Do-All
10 units of Superword
Multiple Cost Drivers

• In many cases there may be multiple cost drivers

Do-All Software Example


Variable costs: $40 per software package sold
$15 per invoice issued
Operating income
= Revenue – ($40 x packages sold) – ($15 x invoices issued) –
Fixed costs

• In cases where there are multiple cost drivers there are


multiple breakeven points
Contribution Margin & Gross Margin

Merchandising Sector

Contribution Margin Gross Margin


Format Format
Revenues $200 Revenues $200
Variable costs:
Cost of goods sold (120+5) 125
Cost of goods sold $120
Other variable 43 163 Gross margin 75
Contribution margin 37 Operating costs (43+19) 62
Fixed costs:
Operating income $13
Cost of goods sold 5
Other fixed 19 24
Operating income $13
Contribution Margin & Gross Margin

Manufacturing Sector

Contribution Margin Gross Margin


Format Format
Revenues $1,000 Revenues $1,000
Variable costs:
Cost of goods sold (250+160) 410
Manufacturing $250
Non-manufacturing 270 520 Gross margin 590
Contribution margin 480 Non-manufacturing (270+138) 408
Fixed costs:
Operating income $182
Manufacturing 160
Non-manufacturing 138 298
Operating income $182
Decision Models and Uncertainty

• Managers make predictions and decisions in a world


of uncertainty
• Estimate events that are likely to occur and assign
probabilities to each outcome
• Probability distribution describes the likelihood of
each mutually exclusive and collectively exhaustive set
of events (must add to 1.00)
• Expected value is a weighted average of the outcomes
with the probability of each outcome serving as the
weight
Uncertainty Example

0.5
Probability
Proposal A: 0.4
Spy Novel 0.3

0.2
1 2 3 4 5 6 7 8 9
Cash Inflow ($000,000)
0.1

Expected value
= (0.1*$300,000) + (.02*$350,000) + (.04*$400,000) +
(0.2*$450,000) + (0.1*$500,000)
= $400,000
THANK YOU

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