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Cost-Volume-Profit Analysis
Cost-Volume-Profit
Analysis
CVP analysis is a technique for studying the relationship between
cost, volume and profits. Examines the behavior of total
revenues, total costs, and operating income as changes occur in
the output level, selling price, variable costs or fixed cost
It can be used to answer the questions like:
a. How much sales should be made to avoid the losses?
b. How much should be the sales to earn a desired profit?
c. What will be the effect of change in prices, costs and volume on
profits
d. Which product or product mix is most profitable?
e. Should we manufacture or buy some product or component?
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Assumptions of CVP
Analysis
Expenses can be classified as either variable or fixed.
CVP relationships are linear over a wide range of production and
sales.
Sales prices, unit variable cost, and total fixed expenses will not vary
within the relevant range.
Volume is the only cost driver.
The relevant range of volume is specified.
Inventory levels will be unchanged.
The sales mix remains unchanged during the period.
revenues change in relation to production and sales
costs and prices are known
if more than one product exists, the sales mix is constant
we can ignore the time value of money
Objectives
Identify how changes in volume affect costs.
Use CVP analysis to compute breakeven point.
Use CVP analysis for profit planning and graph the
cost-volume-profit relations
Use CVP method to perform sensitivity analysis.
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 %
Packages Sold
0 12 2540
Revenue 0200 4005,0008,000
Variable costs 0120 2403,0004,800
Contribution margin 080 1602,0003,200
Fixed costs 2,0002,0002,000 2,0002,000
Operating income (2,000)(1,920)(1,840) 01,200
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Computing Break-Even
Point
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Margin Of Safety
Excess of actual or budgeted sales over
the break – even sales is known as MOS
Variable
Fixed
Mixed
Total Variable Cost
Total variable costs change
when activity changes.
Total Long Distance
Minutes Talked
Variable Cost Per Unit
Variable costs per unit do not change
as activity increases.
The cost per long
Telephone Charge
distance
Per Minute
minute talked is
constant.
For example, 2 Rs. per
minute.
Minutes Talked
Total Fixed Cost
Total fixed costs remain unchanged
when activity changes.
Telephone Bill
Monthly Basic
–
–
0 1 2 3 4 5
Volume
(Thousands of passengers)
Mixed Costs
Contain fixed portion that is incurred
even when facility is unused & variable
portion that increases with usage.
Example: monthly electric utility
charge
Fixed service fee
Variable charge per kilowatt hour used
Mixed Costs
Total Utility Cost
ost
d c Variable
i xe
l m Utility Charge
o ta
T
Fixed Monthly
Utility Charge
Activity (Kilowatt Hours)
Preparing a CVP Chart
➊ Plot total fixed costs on the vertical axis.
Costs and Revenue
Total costs
Volume in Units
Preparing a CVP Chart
Starting at the origin, draw the sales line Sales
with a slope equal to the unit sales price.
Costs and Revenue
Total costs
Break-even
Point
Volume in Units
Various Sales Levels
Example
What operating income is expected when
sales are 80,000 units?
Windows Doors
Selling Price $200 $500
Variable Cost 125 350
Unit Contribution $ 75 $ 150
Sales Mix Ratio 4 1
Computing Multiproduct
Break-Even Point
Step 1: Compute contribution margin per
composite unit.
Windows Doors
Selling Price $200 $500
Variable Cost 125 350
Unit Contribution $ 75 $ 150
Sales Mix Ratio
Composite C/M
Computing Multiproduct
Break-Even Point
Sales Composite
Product Mix Units Units
Window 4 × 2,000 = 8,000
Door 1 × 2,000 = 2,000
Multiproduct Break-Even
Income Statement
Step 4: Verify the results.