The relationships among revenue, cost, profit and volume can be expressed graphically by

preparing a cost-volume-profit (CVP) graph or break even chart. A CVP graph

highlights CVP relationships over wide ranges of activity and can give managers a
perspective that can be obtained in no other way.

Preparing a CVP Graph or Break-Even Chart:

In a CVP graph some times called a break even chart unit volume is commonly represented
on the horizontal (X) axis and dollars on the vertical (Y) axis. Preparing a CVP graph
involves three steps.

1. Draw a line parallel to the volume axis to present total fixed expenses. For example we
assume total fixed expenses $35,000.

2. Choose some volume of sales and plot the point representing total expenses (fixed and
variable) at the activity level you have selected. For example we select a level of 600 units.
Total expenses at that activity level is as follows:

Fixed Expenses $35,000

Variable Expenses (150×600) $90,000
 ---------
Total Expenses $125,000
======

After the point has been plotted, draw a line through it back to the point where the fixed
expenses line intersects the dollars axis.

3. Again choose some volume of sales and plot the point representing total sales dollars at
the activity level you have selected. For example we have chosen a volume of 600 units.
sales at this activity level are $150,000 (600units × $250) draw a line through this point
back to the origin. The break even point is where the total revenue and total expense lines
cross. See the graph and note that break even point is at 350 units. It means when the
company sells 350 units the profit is zero. When the sales are below the break even the
company suffers a loss. When sales are above the break even point, the company earns a
profit and the size of the profit increases as sales increase.

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Definition of Break Even point:

Break even point is the level of sales at which profit is zero. According to this definition, at
break even point sales are equal to fixed cost plus variable cost. This concept is further
explained by the the following equation:

[Break even sales = fixed cost + variable cost]

The break even point can be calculated using either the equation method or contribution
margin method. These two methods are equivalent.

Equation Method:
The equation method centers on the contribution approach to the income statement. The
format of this statement can be expressed in equation form as follows:

Profit = (Sales − Variable expenses) − Fixed expenses

Rearranging this equation slightly yields the following equation, which is widely used in cost
volume profit (CVP) analysis:

Sales = Variable expenses + Fixed expenses + Profit

According to the definition of break even point, break even point is the level of sales where
profits are zero. Therefore the break even point can be computed by finding that point
where sales just equal the total of the variable expenses plus fixed expenses and profit is
zero.

Example:
For example we can use the following data to calculate break even point.

• Sales price per unit = $250

• variable cost per unit = $150
• Total fixed expenses = $35,000

Calculate break even point

Calculation:

Sales = Variable expenses + Fixed expenses + Profit

$250Q* = $150Q* + $35,000 + $0**

$100Q = $35000

Q = $35,000 /$100

Q = 350 Units

Q* = Number (Quantity) of units sold.

**The break even point can be computed by finding that point where profit is zero

The break even point in sales dollars can be computed by multiplying the break even level
of unit sales by the selling price per unit.

350 Units × $250 Per unit = $87,500

Break even cost=FC+VC=$35000+150*350=$87500

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Contribution Margin Method:

The contribution margin method is actually just a short cut conversion of the equation
method already described. The approach centers on the idea discussed earlier that each unit
sold provides a certain amount of contribution margin that goes toward covering fixed cost.
To find out how many units must be sold to break even, divide the total fixed cost by the
unit contribution margin.

Break even point in units = Fixed expenses / Unit contribution margin

$35,000 / $100* per unit

350 Units

*S250 (Sales) − $150 (Variable exp.)

A variation of this method uses the Contribution Margin ratio (CM ratio) instead of the unit
contribution margin. The result is the break even in total sales dollars rather than in total
units sold.

Break even point in total sales dollars = Fixed expenses / CM ratio

$35,000 / 0.40

= $87,500

This approach is particularly suitable in situations where a company has multiple products
lines and wishes to compute a single break even point for the company as a whole.

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Target profit is the amount of net operating income or profit that management desires to
achieve at the end of a business period. Management needs to know the required level of
business activities to get target profits.

Cost volume profit (CVP) equations and formulas can be used to determine the sales volume
needed to achieve a target profit. The explanation of target profit analysis requires an
example.

Example:
• Sales price per unit = $250
• Variable cost per unit = $150
• Total fixed expenses = $35,000
• Target Profit = $40,000
• Q = Number (Quantity) of units sold

Required:
How many units will have to be sold to earn a profit of $40,000?

Solution:
The CVP Equation Method:

Under CVP equation approach, we can find the number of units to be sold to obtain target
profit by solving the equation where profits are equal to target profit (that is $40,000).

Sales = Variable expenses + Fixed expenses + Profit

$250Q = $150Q + $35,000 + $40,000

 $100Q = $75,000

Q = $75,000 / $100 per unit

Q = 750 Units

Thus the target profit can be achieved by selling 750 units per month, which represents
$187,500 in total sales ($250 × 750 units). This equation is also extensively used to
calculate break even point. When break even point is calculated the value of profit in the
equation is taken equal to ZERO.

The Contribution Margin Approach:

A second approach involves expanding the contribution margin formula to include the
target profit.

[Unit sales to attain target profit = (Fixed expenses + Target Profit) ÷ Unit
contribution margin]

This approach gives the same answer as the equation method since it is simply a short cut
version of the equation method. similarly the dollar sales needed to attain the target profit
can be computed as follows:

Dollar sales to attain the target profit = [(Fixed expenses + Target profit) ÷ CM ratio]

= ($35,000 + $40,000) ÷ 0.40

= $187,500

No. of units to be sold = $187,500 / $250

=750 units

Review Problem:
Voltar Company manufactures and sells a telephone answering machine. The Company's
contribution margin format income statement for the most recent year is given below:

Percent of
Total Per Unit
Sales
Sales (20,000 units) $1,200,000 $60 100%
Less variable expenses 900,000 45 ?%
----------- ----------- -----------
Contribution margin 300,000 $15 ?%
Less fixed expenses 240,000 ====== ======
------------
Net operating income $60,000
 ======

Management is anxious to improve the company's profit performance. Assume that next
year management wants the company to earn a minimum profit of $90,000. How many
units will have to be sold to meet the target profit figure?

Solution:
Equation Method:

Sales = Variable expenses + Fixed expenses + Profits

$60Q = $45Q + $240,000 + $90,000

$15Q = $3330,000

Q = $3330,000 / $15 Per unit

Q = 22,000 Units

Contribution Margin Method:

[(Fixed expenses + Target profit) / Contribution margin per unit]

[($240,000 + $90,000) / $15 Per unit]

22,000 Units

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