1 cost volume profit analysis by ghanendra fago for mba, aim

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Cost Volume Profit Analysis

By Ghanendra Fago

For MBA, AIM

By Ghanendra Fago (M. Phil, MBA)For AIM

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Cost-Volume-Profit Analysis Study of relationship between costs, volume, and

profits. If 10% volume changed, what is the expected

change in profit and cost? If 10% cost changed, If volume and cost changed, what is the expected

change in profit? Break even analysis – A techniques of CVP

analysis


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Use of CVP Analysis

What level of sales is needed to avoid the losses? What sales volume is needed to earn a target profit? What would be the effect on profits if we reduce our selling

price and sell more units? What sales volume is required to meet the additional fixed

charges arising from an advertising campaign? What will be the effect on the profit, where sales mix is

changed? What will be the new-break-even point when there is change

in prices, costs, volume, and sales mix? Which product or product mix is most profitable? Which product or product mix should be discontinued or

not?


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Assumptions of CVP Analysis i.e

Certainty Analysis

Costs can be divided into fixed and variable elements

Fixed costs will remain constant

Variable cost per unit and selling price remain constant.

A company produces a single product. If multiple

product mix remains constant.

Production equals to sales i.e. there is no change in

inventory.

No change in capacity and productivity.


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Break Even analysis

Break-even analysis is a technique of representing and studying the inter-relationship of the three basic components of CVP: cost, volume and profit.

The break-even analysis determines a relationship between the revenues and costs with respect to volume.

Break-even analysis is always taken as an important part of profit planning as it gives the planner many insights into the data with which he or she is working.

It is a point where the profit is zero as the total revenues are equal to total costs. In other words, it is that level of activity (in units or in Rs.) at which revenue equals cost.


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Methods of CVP Analysis

Graphic approach Income statement Approach Contribution margin or Formula approach Equation approach


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Cost

,Pr

ice,

Pro

fit (i

n 00

0 Rs

.)

50 100 150 200 250

50

100

150

200

250

Quantity in units (in 000 units)

Loss

Profit

BE Point

VariableCost

Fixed Cost

Sales revenue

Total cost

Margin of safety 0

Graphic Analysis of Break Even Point


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Income Statement Approach

Particulars Amounts %

Sales 10,000 units @ Rs10 per unit

Less: Variable cost @ Rs. 4 per unit

Rs. 100,000

40,000

100%

40%

Contribution Margin @ Rs. 6 per unit

Less: Fixed costs

60,000

50,000

60%

Net profit 10,000


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Variable Income Statement

Sales in units

Sales revenue @Rs 20

Less: variable cost @Rs 12

Contribution margin @Rs 8

Less: fixed cost

Net income before tax

56,250

11,25,000

6,75,000

4,50,000

4,50,000

0


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Contribution Margin Approach Or Formula Approach

The approach uses the concept of contribution

margin and contribution margin ratio.

To find out the number of units to be sold to

break-even, the fixed cost can be divided by

contribution margin contributed by each unit sold.

Break Even Point (in units)

= Fixed cost/CMPU = ….. units

= Fixed cost/PV ratio = ….. in Rupees


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Formulae of Cost Volume Profit Analysis

1. Contribution Margin per Unit (CMPU) = Selling Price per unit – Variable cost per unit

= Selling Price per unit x PV ratio= Difference in Profit/difference in sales units= Profit/margin of safety units

2. Profit Volume (Contribution margin) Ratio= 1 –CV ratio or = 1- VCPU/SPPU= Difference in Profit/difference in sales revenues= 1- Difference in costs/ difference in sales= Profit/margin of safety rupees

3. Break Even Point (in units) = Fixed cost/CMPU = … units = Fixed cost/PV ratio = ….in Rupees


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4. Required sales to earn desired profit: Target sales volume to earn profit before tax in rupees

= FC+ before tax target profit/Contribution margin ratio

Target sales volume to earn profit before tax in units= FC+ before tax target profit/Contribution margin per unit

Target sales volume to earn after tax (in rupees)= FC+{(desired profit after tax) / (1-t)}/Contribution margin ratio

Target sales volume to earn after tax (in units= FC+{(desired profit after tax) / (1-t)}/Contribution margin per unit


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5. Profit on Sales = Sales – Variable Cost – Fixed Cost

= (Sales Rs. P/V Ratio) – Fixed Cost

= (Sales Units CMPU) – Fixed Cost

= Margin of Safety CMPU

6. Margin of Safety = Actual Sales – Break Even Sales

= Margin of Safety/Actual sales

= Profit/CMPU or PV ratio

7. Sales to earn equal profit by two alternative=Differences in fixed costs/difference in PV ratio or CMPU


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Multi Products/Sales Mix

Overall BEP (in Rs.) =Total fixed costs/WAPV ratio =Rs….

Overall BEP (Units) = Total fixed costs/WACMPU = Units

Calculation of weighted average CMPU

Product Sales units

Sales Mix CMPU Contribution

X

Y

Weighted Average CMPU


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Product Sales In amount

Sales Mix PV Ratio Contribution (PV ratio Sales

Mix)

X

Y

Weighted Average PV ratio

Weighed Average profit Volume Ratio PV ratio

By Equation:Sales revenues = Fixed costs + variable costs + profitIn units: x = FC + VC + Profit

or, x = FC + VC ratio (x) + profitIn Rs: Sales price (x) = FC + VC + profit

or, sales price (x) = FC + VC rate (x) + profit


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Cost Volume Profit Analysis Under Changing Situations - Sensitivity Analysis

• Sensitivity analysis is the measurement of

responsiveness in outcome with the change in

determination variables. • As the goal of a business, enterprise is to maximize

profits.• Profits are the excess of revenue over the total costs• To measure the sensitivity of CVP factors, the impact of

certain percentage of change in volume, price, or cost

factor on net profits must take into consideration.


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Change in selling price

The change in selling price will affect the profit

volume ratio and thus the break-even point. An

increase in selling price will increase the PV ratio

and will lower the break-even point. The reverse

will have opposite effect i.e., decrease in selling

price will reduce PV ratio and it results in to

higher BEP.


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Change in variable costs

The change in variable costs has an opposite

reaction to the PV ratio i.e. decrease in variable cost

result in increase in PV ratio, whereas increase in

variable cost shall result in decrease in the PV ratio.

A decrease in PV ratio results into higher BEP and

reduced profit and vice-versa.


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Change in fixed costs

A change in fixed cost does not have any

effect on the PV ratio but it affects the break-

even point and ultimately the profit. A

decrease shall lower the BEP and increase

the profit. Any increase pushes the break-

even point and reduces the profits.

1 cost volume profit analysis by ghanendra fago for mba, aim

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