CVP Analysis

CVP Analysis
CVP Analysis is based on a simple model of how

profits respond to prices, costs and volume.
Prices of
products
Volume
Mix of
or level
products
of
sold
activity
Total Per unit

fixed variable
costs costs.
Profit
Planning
Analyzing
product
Why Decision
making
mix CVP ?
Balancing
sales
Selling Price is Constant.
Assumptions of CVP
Inventories do not change.
Production = Sales
Costs can be divided into variable and
fixed elements.
The sales mix is constant in multiproduct

companies.
Contribution Margin (CM)
Contribution Margin is the amount remaining
from sales after variable expenses have been
deducted.
Contribution Margin = Sales – Variable Expenses
Contribution Margin Ratio:
The Contribution Margin as a percentage of sales is
referred to as the CM Ratio.
CM Ratio = Contribution Margin/Sales
Break Even Point (BEP)
Break even point is the point at which Profit is
Zero.
1. BEP [Unit] = Fixed Cost / CM
2. BEP [Taka] = Fixed Cost / CM Ratio
3. Sales = Variable Cost + Fixed Cost+ Profit
****Note that in the BEP, Profit is Zero

Break Even Point
Example#1
Calculate break-even point in sales units and
sales dollars from following information:
– Price per Unit $15
– Variable Cost per Unit $7
– Total Fixed Cost $9,000
Break Even Point
Example#2
It costs a publishing company 50,000 dollars to

make books. The 50,000 is a fixed cost or a cost
that cannot change. To help the publishing
company sell the books, a marketing
company charges 4 dollars for each book sold. If
the company charges 9 dollars per book, how
many books should they sell to break even?
Break Even Point
Example#3
It costs a man 75 dollars to buy the things that

he needs to make hotdogs. The city allows him
to sell his hotdog somewhere near the city hall.
However, the city hall charges him 1 dollar for
each hotdog sold.
Calculate the break even point if the price
he charges for 1 hotdog is $1.50
Change in Fixed Cost & Sales Volume
ABC Company is currently selling 400 speakers
per month at 250 Taka per speaker for total
monthly sales of 1,00,000 Taka. Variable
Expense is 150 taka/Unit. The sales manager
feels that a 10,000 increase in the monthly
advertising budget would increase monthly sales
by 30,000 Taka to a total of 520 Units. FC =
35,000 Taka. Should the advertising budget be
increased ?
Solution
Current New Difference % of
Sales Sales Sales
Sales 100000 130000 30000 100%
Variable Expenses 60000 78000 18000 60%
Contribution Margin 40000 52000 12000 40%
Fixed Expense 35000 45000 10000
Net Operating Income 5000 7000 2000
Alternative:
Incremental Contribution Margin (30,000*40%) 12,000
Incremental Advertising Expense 10,000
Increased Net Operating Income 2000
Changes in FC, Sales Price & Volume
Selling Price=250/Unit, VC =150/Unit, FC=35,000
ABC Company is currently selling 400 Speakers
per month. To increase sales, the sales manager
would like to cut the selling price by 20 Taka per
speaker and increase advertising budget by
15,000 Taka per month. The sales manager
believes that if the changes took place, unit
sales will increase by 50% to 600 Speakers per
month. Should the changes be made?
Current New Difference
Sales Sales
Sales 100000 138000 38000
Variable Expenses 60000 90000 30000
Contribution Margin 40000 48000 8000
Fixed Expense 35000 50000 10000
Net Operating Income 5000 (2000) (2000)
Alternative:
Expected CM with new Price (600 Unit * 80 Taka) 48,000
Present Contribution Margin (400 Unit * 100 Taka) 40,000
Incremental Contribution Margin 8000
Incremental Advertising Expense 15000
Reduction in Net Operating Income (7000)
Changes in FC,VC & Volume
Selling Price=250/Unit, VC =150/Unit, FC=35,000
The company is currently selling 400 Speakers
per month. The sales manager would like to pay
salespersons a sales commission of 15 Taka per
speaker sold, rather than the flat salaries that
now total 6000 per month. It is expected that
the monthly sales would increase by 15% to 460
Speakers if the new action is implemented.
Should the change be made ?
Current New Difference
Sales Sales
Sales 100000 115000 15000
Variable Expenses 60000 75900 15900
Contribution Margin 40000 39100 900
Fixed Expense 35000 29000 (6000)
Net Operating Income 5000 10100 5100
Alternative:
Expected CM with new Price (460 Unit * 85 Taka) 39,100
Present Contribution Margin (400 Unit * 100 Taka) 40,000
Incremental Contribution Margin (900)
Savings of Fixed Cost (Salaries) 6000
Increase in Net Operating Income 5100
Target Profit Analysis
1. Sales = Variable Cost + Fixed Cost + Target Profit
2. Fixed Expense + Target Profit / Unit CM

The Margin of Safety
The Margin of Safety = Sales – Break even Sales

Operating Leverage
Operating leverage is a measure of how
sensitive net operating income is to a giver
percentage change in dollar sales.
Degree of Operating Leverage

=
CM/Net operating income
Review Problem: CVP Relationships
Voltar Company manufactures and sells a specialized cordless

telephone for high electromagnetic radiation environments.
The company's contribution format income statement for the
most recent year is given below:
Required
1. Compute the company's CM ratio and variable expense ratio.
2. Compute the company's break-even point in both units and sales dollars.
Use the equation method.
3. Assume that sales increase by $400,000 next year. If cost behavior patterns
remain unchanged, by how much will the company's net operating income
increase? Use the CM ratio to compute your answer.
4. Refer to the original data. Assume that next year management wants the
company to earn a profit of at least $90,000. How many units will have to be
sold to meet this target profit?
5. Refer to the original data. Compute the company's margin of safety in both
dollar and percentage form.
6. Compute the company's degree of operating leverage at the present level
of sales.
7. Assume that through a more intense effort by the sales staff, the
company's sales increase by 8% next year. By what percentage would you
expect net operating income to increase? Use the degree of operating
leverage to obtain your answer.
8. Verify your answer to (b) by preparing a new contribution format income
statement showing an 8% increase in sales.
1. Compute the company's CM ratio and variable expense ratio.

CMR = 25%; VC ratio = 75%
2. Compute the company's break-even point in both units and sales dollars. Use the equation
method.
60 Q = 45Q + 240,000 - > 15 Q = 240,000 -> Q = 16,000 units
16,000 * 60 = $960,000
3. Assume that sales increase by $400,000 next year. If cost behavior patterns remain
unchanged, by how much will the company's net operating income increase? Use
the CM ratio to compute your answer.
Increase in sales $400,000

CMR 25%
Increase in NOI $100,000
4. Refer to the original data. Assume that next year management wants the
company to earn a profit of at least $90,000. How many units will have to
be sold to meet this target profit?
(240,000 + 90,000)/15 = 22,000 units
5. Refer to the original data. Compute the company's margin of safety in

both dollar and percentage form.
Margin of safety = 1,200,000 – 960,000 = $240,000 or 20%
6. Compute the company's degree of operating leverage at the present level

of sales.
DOL = 300,000 / 60,000 = 5

7. Assume that through a more intense effort by
the sales staff, the company's sales increase by
8% next year. By what percentage would you
expect net operating income to increase? Use
the degree of operating leverage to obtain your
answer.
5 * 8% = 40%
8. Verify your answer to (b) by preparing a new
contribution format income statement showing
an 8% increase in sales.
Sales $1,296,000
VC 972,000
CM 324,000
FC 240,000
NOI $84,000
40% increase
9. Refer to the original data, In an effort to increase sales and profits, management is
considering the use of a higher-quality speaker. The higher-quality speaker would increase
variable costs by $3 per unit, but management could eliminate one quality inspector who is
paid a salary of $30,000 per year. The sales manager estimates that the higher-quality
speaker would increase annual sales by at least 20%.
A. Assuming that changes are made as described above, prepare a projected contribution
format income statement for next year. Show data on a total, per unit, and percentage
basis.
B. Compute the company's new break-even point in both units and dollars of sales. Use
the contribution margin method.
C. Would you recommend that the changes be made?
9A. Assuming that changes are made as described above, prepare a projected
contribution format income statement for next year. Show data on a total, per
unit, and percentage basis.
Sales 24000 * 60 = 1440000
VC 24000*48 = 1152000
CM = 288000
FC = 210000
Net Profit = 78000
9B. Compute the company's new break-even point in both units and dollars of
sales. Use the contribution margin method.
BE units = FC/ CM per unit = 210,000/ 12 = 17,500 units
17,500 * 60 = $1,050,000
9C. Would you recommend that the changes be made?

Profit increased by (78000-60000)= 18000. Recommended.

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CVP Analysis

CVP Analysis is based on a simple model of how

Total Per unit

The sales mix is constant in multiproduct

****Note that in the BEP, Profit is Zero

It costs a publishing company 50,000 dollars to

It costs a man 75 dollars to buy the things that

1. Sales = Variable Cost + Fixed Cost + Target Profit

2. Fixed Expense + Target Profit / Unit CM

The Margin of Safety = Sales – Break even Sales

Degree of Operating Leverage

Voltar Company manufactures and sells a specialized cordless

1. Compute the company's CM ratio and variable expense ratio.

Increase in sales $400,000

(240,000 + 90,000)/15 = 22,000 units

5. Refer to the original data. Compute the company's margin of safety in

Margin of safety = 1,200,000 – 960,000 = $240,000 or 20%

6. Compute the company's degree of operating leverage at the present level

DOL = 300,000 / 60,000 = 5

9C. Would you recommend that the changes be made?

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