Cost Volume Profit Analysis

COST VOLUME PROFIT ANALYSIS
Cost volume profit analysis a systematic examination of the relationships

among cost, cost drivers or activity level (or volume), and profit
ELEMENTS OF CVP ANALYSIS
1.
2.
3.
4.
Sales (Selling price, units or volume)

Total fixed cost
Variable costs per unit
Sales mix
APPLICATIONS OF CVP ANALYSIS

Planning and decision-making, which may involve choosing the:
1. Type of product to produce and sell
2. Pricing policy to follow
3. Marketing strategy to use, and
4. Type of productive facilities to acquire
THE CONTRIBUTION MARGIN INCOME STATEMENT
The cost and expenses in the contribution margin income statement are
classified as to behaviour (variable and fixed). The amount of contribution
margin, which is the difference between sales and variable costs, is shown. The
format is as follows:
Sales (units x selling price)
Pxx
Less: Variable costs (units x variable cost per unit)
xx
Contribution Margin
Pxx
Less: Total fixed costs

Income before tax
xx
Pxx
The contribution margin income statement is prepared for managements own

use. The format facilitates cost-volume-profit analysis.
INHERENT SIMPLIFYING ASSUMPTIONS OF CVP ANALYSIS
1. All costs are classified as either variable or fixed
2. Cost and revenue relationships are predictable and linear over relevant
range of activity and a specified period of time
3. Total variable costs change directly with the cost driver, but variable cost
per unit are constant over the relevant range
4. Total fixed costs are constant over the relevant range, but fixed costs per
unit vary inversely with the cost driver or volume
5. Selling prices per unit and market conditions remain unchanged
6. Production equals sales, i.e., there is no change in inventory
7. If the company sells multiple products, sales mix is constant
8. Technology, as well as productive efficiency, is constant

9. The time value of money is ignored .
BREAK-EVEN ANALYSIS
Break-even point the sales volume level (in pesos or in units) where total
revenue equals total costs, that is there is neither profit nor loss
METHODS OF DETERMINING THE BREAK-EVEN
A. GRAPHICAL METHOD
SALES
TOTAL COSTS
BEP
FIXED COSTS
B. CONTRIBUTION MARGIN METHOD (FORMULA APPROACH)
a. Single break-even calculations

1. Break-even point in pesos
BEP= FxC/CMR
Where:
BEP=break even point

FxC=total fixed costs
CMR=contribution margin ratio
CM/u=contribution margin per unit
2. Break-even point in units

BEP=FxC/CM per unit
Other Formulas:
CM= S-VC
where
CM/u= SP-VC per unit
CM=contribution margin
CMR = CM / S
S= Sales
VCR = VC/S
VC = Variable costs
CMR + VCR = 100%
SP = Selling price
CMR = 1-VCR
ratio
CMR = contribution margin
VCR = 1-CMR
VCR = variable costs ratio
Example: Consider the following data:

Sales (10,000 units @ P10)
100,000
Variable costs (10,000 units @ P6)
60,000
Contribution Margin (10,000 units @ P4)
40,000
Fixed Costs
30,000
Profit
10,000
The break-even point in units is:

BEP = FxC / CM per unit
30,000/4
= 7,500 units
The break-even point in pesos is:

BEP = FxC / CMR
30,000 / 40%
=P75,000
CMR = CM/S
40,000/100,000
=40%
b. Multiple-Product/Service break-even calculations

BEPp
CMR
= FxC / WaCMR
where: WaCMR=weighted average
BEP u = FxC / WaUCM

unit CM
WaUCM=weighted average
Illustrative Example
A company sells Products A, B and C. Data about the three products are as
follows:
Selling price
Product A
Product B
Product C
100
120
50
60
90
40
Contribution margin per unit
40
30
10
Sales in units
1,000
2,000
5,000
Total fixed costs
Total
101,680
1. Break-even point in pesos is:

BEP p = FxC / WaCMR
=
101,680/25.42%
=P400,000
Computation of weighted average contribution margin ratio (WaCMR)
Product A
Product B
Product C
Total
Selling price
100
120
50
60
90
40
Contribution margin per unit
40
30
10
WaCMR =
Total CM / Total Sales
150,000/590,000
=25.42%
BREAKDOWN OF BREAK-EVEN SALES:

Product A
Total BE sales x Sales mix ratio
42.37%
Product B
16.95%
67,800
Product C
Total
40.68%
162,720
169,480
P400,000
2. Breakeven point in units
BEP u = FxC / WaUCM
=
101,680/18.75
=5,423 units
Computation of weighted average unit contribution margin (WaUCM)

WaUCM = Total CM / Total Units =
150,000 / 8,000
=P18.75
Product B
Total
Breakdown of the break-even sales:

Product A
Total BE sales x Sales mix ratio
12.5%
677.87
Product C
25%
62.5%
1,355.73
3,389.33
5,422.93
Margin of Safety
Margin of safety the amount of peso-sales or the number of units by which
actual or budgeted sales may be decreased without resulting into a loss
Formulas:
MS p=
Sp BEPp
MSu= Su BEPu or MSp / SP

MSR = MSp / Sp or MSu / Su
Where
MSp=margin of safety in pesos

MSu= margin of safety in units
MSR= margin of safety ratio
Sp=sales in pesos
Su=sales in units
BEPp=break-even point in pesos
BEPu=break-even point in units
SP=selling price
Example:
If a companys present sales is 100,000 units or P500,000 and the break-even
point is 60,000 units:
a. MSp = P500,000 P300,000 = P200,000
b. MSu = 100,000 60,000 = 40,000 units or MSu = P200,000/P5 = 40,000
units
c. MSR = P200,000/P500,000 = 40%
The company can reduce its present sales of P500,000 by P200,000 or by 40,000
units,or by 40% without incurring a loss
OPERATING LEVERAGE
A Company has an operating leverage if it has a very high contribution margin
despite its having high fixed costs
Operating leverage factor (OLF) or degree of operating leverage used to
measure the extent of the change in profit before tax resulting from change in
sales
DOL or OLF = Total CM / Profit before tax or %change in profit before tax / %
change in sales
% change in profit = % change in sales x DOL
Illustrative example
Following is the company s result of operations from its present sales level of
10,000 units:
Sales (10,000 units x P5)
50,000
Variable costs (10,000 x P3)
30,000
Contribution Margin
20,000
Fixed Costs
12,000
Profit before tax
8,000
Based on the above data:

OLF = Total CM / Profit before tax
20,000/8,000
=2.5
If the companys sales would increase by 10%, its profit before tax would
increase by 25%
% change in profit = % change in sales x OLF = 10% x 2.5
= 25%
Notes:
1. Sales increased by only 10%, but profit increased 2.5 times the increase in
sales or by 25%.
2. The increase of 10% in sales is due to change in units
3. Since units changed by 10%, both the total variable costs and contribution
margin increased by the same percentages (10%)
4. Selling price, variable costs per unit and total fixed costs are assumed to
be constant
5. If there is no change in selling price and variable costs per unit, CM per
unit, CMR, and VCR will all remain the same.
REQUIRED SALES WITH DESIRED PROFIT
Required sales in unit
Required
sales in pesos
A. Single Product
To earn desired amount of profit b4 tax
(FxC + DP) / CMR
(FxC + DP)/CMu
To earn desired amount of profit after tax

(NP / 1-TxR)/CMR
FxC + (NP / 1-TxR) / CMu
To earn desired profit ratio

(CMR-PR)
FxC / (Cmu Pu)
FxC +
FxC /
B. Multiple products
To earn desired amount of profit before tax
(FxC + DP) / WaCMR
(FxC + DP) / WaUCM
To earn a desired amount of profit after tax

(NP/1-TxR
WaCMR
FxC+(NP/1-TxR)/WaUCM FxC +
CHANGE IN PROFIT FACTORS

A Change in any of the following profit factors may cause profit to change
1. Selling price
2. Variable costs per unit
3. Volume
4. Total fixed costs
5. Sales mix

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COST VOLUME PROFIT ANALYSIS

Cost volume profit analysis a systematic examination of the relationships

Sales (Selling price, units or volume)

APPLICATIONS OF CVP ANALYSIS

Less: Variable costs (units x variable cost per unit)

Less: Total fixed costs

The contribution margin income statement is prepared for managements own

8. Technology, as well as productive efficiency, is constant

B. CONTRIBUTION MARGIN METHOD (FORMULA APPROACH)

a. Single break-even calculations

BEP=break even point

2. Break-even point in units

CM/u= SP-VC per unit

CMR + VCR = 100%

CMR = contribution margin

VCR = variable costs ratio

Example: Consider the following data:

Variable costs (10,000 units @ P6)

Contribution Margin (10,000 units @ P4)

The break-even point in units is:

The break-even point in pesos is:

b. Multiple-Product/Service break-even calculations

where: WaCMR=weighted average

BEP u = FxC / WaUCM

Variable costs per unit

Contribution margin per unit

Total fixed costs

1. Break-even point in pesos is:

Variable costs per unit

Contribution margin per unit

Total CM / Total Sales

BREAKDOWN OF BREAK-EVEN SALES:

Computation of weighted average unit contribution margin (WaUCM)

Breakdown of the break-even sales:

MSu= Su BEPu or MSp / SP

MSp=margin of safety in pesos

Variable costs (10,000 x P3)

Profit before tax

Based on the above data:

To earn desired amount of profit after tax

FxC + (NP / 1-TxR) / CMu

To earn desired profit ratio

FxC / (Cmu Pu)

(FxC + DP) / WaUCM

To earn a desired amount of profit after tax

CHANGE IN PROFIT FACTORS

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