COST VOLUME PROFIT ANALYSIS PPT-5

Cost Volume Profit Analysis

Cost Drivers

Variable & Fixed Cost Behaviour

Difficulties in classifying cost Break Even Point

Margin of Safety

Cost-Volume-Profit Assumptions and Terminology

1. Changes

in the level of revenues and costs arise only because of changes in the number of product (or service) units produced and sold. costs can be divided into a fixed component and a component that is variable with respect to the level of output.

2. Total

MARGINAL COSTING
Marginal costing is not a system of costing, but it is a special technique

concerned particularly with the effect, which fixed overhead has on the running of a business and this technique is extensively used in all industries for profit planning, cost control and decision-making. Marginal cost is the amount at any given volume of output by which aggregate costs are changed if the volume of output is increased or decreased by one unit. Under the marginal costing system, costs are classified under fixed cost and variable cost. Marginal cost is, the total variable cost (i.e. Direct Materials, Direct Labour, Direct Expenses and variable overheads) because within the capacity of the organization, an increase of one unit in production will cause and increase in variable cost only.

Abbreviations
SP = Selling price VCU = Variable cost per unit C = Contribution per unit
P/V Ratio= Contribution margin percentage

F = Fixed costs

CONTRIBUTION
Contribution is the difference between the sales and

the marginal cost of sales and it contributes towards fixed expenses and profit. Thus, contribution will first go to meet fixed expenses and then to earn profit.
CONTRIBUTION = SELLING PRICE (-) MARGINAL COST = FIXED

EXPENSES + PROFIT

Essentials of Cost-Volume-Profit (CVP) Analysis

Contribution margin percentage (contribution margin ratio) is the contribution margin per unit divided by the selling price.

PROFIT VOLUME RATIO

This term is important for studying the profitability of operating of a

business. Profit volume ratio establishes a relationship between contribution and the sales value. The concept of P/V Ratio helps in determining Break Even Point, Profit at any volume of sales, sales required to earn a desired quantum of profit, profitability of products process or departments etc. Management always tries to increase the P/V Ratio of each product.

P / VRatio

Contributi on 100 Sales

Change in Pr ofit P / V Ratio 100 Change in Sales

If Sales value and P/V Ratio are given, contribution for any

amount of estimated sales can be ascertained as under:

Contributi on Sales Value P / V Ratio Fixed Expenses Pr ofit

To find out estimated value of sales with the help of contribution and P/V Ratio
Fixed Expenses Desired Pr ofit Contributi on SalesValue OR P / V Ratio P / VRatio

BREAK EVEN ANALYSIS

A business is said to break even when its total sales are equal to its total costs. A break even point is that volume of sales or production where there is no profit and no loss. At this point contribution is just equal to fixed expenses. If production is enhanced beyond this level, profit shall accrue to the management, and if it is decreased from this

level, loss shall be suffered by the organization. Fixed Expenses Fixed Expenses
B.E.P.(in units ) Contributi on per unit B.E.P.(in value) P / V Ratio

Breakeven Point

Sales

Variable expenses

Fixed expenses

Total revenues = Total costs

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CALCULATION OF OUTPUT OR SALES VALUE AT WHICH A PROFIT IS EARNED

Fixed Expenses Pr ofit Contributi on per Unit

Fixed Expenses Pr ofit Pr ofit Volume Ratio (P / VRatio )

The following formulae may be used in order to ascertain profit:

(i) Pr ofit Sales ( VariableCo st FixedCost ) OR (ii ) Pr ofit ( Sales P / V Ratio ) Fixed Cost
Calculation of Selling Price per unit for a particular B.E.P. :

Fixed Cost Selling Pr ice per unit Unit Variable Cost Desired BEPin Units

Graph Method
378 336 294 252 210 168 126 84 42 0 0 1000
Breakeven

Fixed costs

2000

3000

4000

5000
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Units

Equation Method
(Selling price Quantity sold) (Variable unit cost Quantity sold) Fixed costs = Operating income

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Calculation of Additional Volume required to meet proposed expenditure

Pr oposed Expenditur e In Units OR Contributi on per unit Pr oposed Expenditur e In Value P V Ratio

MARGIN OF SAFETY
Businessmen always try to know how much they are

above the break-even point. This is technically called margin of safety and is calculated by sales or production units at the selected activity and the break even sales or production. A large margin of safety indicates the soundness of the business. Margin of safety can be improved by lowering fixed and variable costs, increasing volume of sales or selling price and changing product mix so as to improve contribution and overall P/V Ratio.
Margin of Safety (in Value) = Total Sales (-) Sales at

B.E.P.

Margin of Safety

M arg in of Safety

Pr ofit P / V Ratio

Or

Pr ofit C perUnit

Margin of safety (in Units) = Total Sales in units (-)

B.E.P. Sales in units or

Total Sales () B.E.P. Sales M arg in of Safety in % 100 Total Sales

Calculation of Sales Volume required to set off Price Reduction:

Sales Needed ( Units )

Fixed Cost Pr esent Pr ofit OR New Contributi on per Unit Fixed Cost Pr esent Pr ofit NewP / VRatio

Sales Needed (Value )

ANGLE OF INCIDENCE

The angel formed by the sales line and the total cost lines at the break-even point is known as angle of incidence. A high rate of profit is indicated by a large angle of incidence and vice versa.

APPLICATION OF MARGINAL COSTING (i) Fixing Selling Price (ii) Effect of reduction of selling price (iii) Determination of optimum output (iv) Exploring foreign market

Target Operating Income

(Fixed costs + Target operating income) divided either by Contribution margin percentage or Contribution margin per unit

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QUESTION 1
The Acme Company produces and sells one product. The revenue and cost structure of the product is given below:
Particulars Selling Price Per Unit Variable Cost Per Unit Total Fixed Cost per year Amount in S.R. 10.00 6.00 1,00,000

COMPUTE THE BREAK EVEN VOLUME IN UNITS AND RUPES

ANSWER 1
C = S V = 10 6 = 4
Fixed Expenses 1,00,000 B.E.P.in Units 25,000 units C per unis 4
C 4 100 100 40% S 10 Fixed Expenses 1,00,000 B.E.P. in Amount 2,50,000 P / V Ratio 40% P.V .Ratio

QUESTION 2
Calculate break even point on the basis of the following information supplied by a manufacturing firm:
PARTICULARS S.R. ESTIMATED SALES ESTIMATED VARIABLE COSTS ESTIMATED FIXED COSTS 10,00,000 6,00,000 2,00,000 AMOUNT IN

ANSWER 2
C = S V = 10,00,000 6,00,000 = 4,00,000
C 4,00,000 P.V .Ratio 100 100 40% S 10,00,000 Fixed Expenses 2,00,000 B.E.P. in Amount 5,00,000 P / V Ratio 40%

QUESTION 3
Following information are available about a company:
COST PER UNIT RAW MATERIALS LABOUR VARIABLE OVERHEADS AMOUN T 25 10 5

Fixed Overheads for PRICE amount to 50 20,000 S.R.. Sales and SELLING the year production was of 10,000 units. You are to find: i. Marginal Cost ii. Contribution per unit iii. Variable cost iv. Total Contribution v. Net Profit

Answer 3
1. 2. 3. 4. 5.

Marginal Cost= Mat + Labour +Variable Overheads = 25+10+5 = 40 Contribution per unit = S M.C. = 50 40 =10 Total Variable Cost = 40 x 10,000 = 4,00,000 Total Contribution = C x Units = 10 x 10,000 = 1,00,000 Net Profit = Total Contribution Fixed Overhead = 1,00,000 20,000 = 80,000

QUESTON 4
The Price structure of a cycle made by the Cycle Company Ltd. is as follows:

PARTICULARS MATERIALS LABOUR

AMOUNT 60 20

VARIABLE OVERHEADS
FIXED OVERHEADS

20
50

50 This is based on PROFIT the manufacture of 1,00,000 cycles per annum. This company expects that due to competition they will have to reduce SELLING PRICE 200 selling price4, but they want tot keep the total profits intact. What level of production will have to be reached, i.e. how many cycles will have to be manufactured to get the same amount of profit, if:i. The selling price is reduced by 10% ii. The selling price is reduced by 20%

ANSWER 4
Present Profit = 100000 x 50 = 50,00,000
Pr esent S .P. 200 90 180 100 80 New S ..P. after 20% Re duction 200 160 100 New S .P. after 10% Re duction 200
C S V 180 100 80 Re quired Sales to earn same amount of Pr ofit C S V 160 100 60 1,00,00,000 cycles 1,66,667 60 F P 50,00,000 50,00,000 1,00,00,000 1,25,000 cycles C 80 80

QUESTION 5
Given the following figures:
PARTICULARS FIXED COSTS SELLING PRICE PER UNIT VARIABLE COST PER UNIT AMOUN T 16,000 8 5

Show the impact of the following changes on break even point: i. Fixed Cost increase by 5,000 S.R. ii. Decrease in Fixed Costs by 4,000 S.R. iii. 20% increase in variable cost iv. Fixed Cost increase by 20% and variable costs decreased by 10%

Answer 5
Pr esent B. E. P. inUnits

Effect of increase in Fixed Costs by 5,000, Now Total Fixed Expenses = 16,000+5,000 = 21,000
New B. E. P. inUnits F 21,000 7,000 units C 3 Fixed Cost by 4,000 , Now

F 16,000 5,333 units C 3

Effect of decrease in Expenses =16,000 - 4,000 = 12,000

Fixed

New B. E. P. inUnits

F 12,000 4,000 units C 3

Contd.
Effect of increase in variable cost by 20% V.C. = 5 + 1 = 6 , New C will be 8 6 = 2
F 16,000 New B. E. P. inUnits 8,000 units C 2

QUESTION 6
The total cost and profits during two period were as follows:
PARTICULARS PERIOD I AMOUNT TOTAL COST PROFIT 4,00,000 50,000 PERIOD II AMOUNT 6,50,000 1,00,000

Calculate: i. P/V Ratio ii. Break Even Sales iii. Sales required to earn a profit of 1,25,000 S.R. iv. Profit earned when sales are 3,50,000 S.R.

Answer 6
Change in Pr ofit 50000 P / V Ratio 100 100 20% Change in Sales 250000
Fixed Expenses Sales P / V Ratio Pr ofit 5,00,000 20% 50000 50,000

B.E.P.Sale

F 50000 2,50,000 P / V Ratio 20%

Fixed Expenses Desired Pr ofit 50,000 1,25,000 8,75,000 P / V Ratio 20%

Sales to earn a Pr ofit 1,25,000

Pr ofit when Sales are 3,50,000 Pr ofit ( Sales P / VRatio ) Fixed Cost 3,50,000 20% 50,000 20,000

QUESTION7
XY Co. Sold in two successive years 7,000 and 9,000 units and incurred a loss of 10,000 S.R. and earned 10,000 as profit respectively. The selling price per unit is 100 S.R. Calculate (a) the amount of fixed costs, (b) the number of units to break even, and (c) the number of units to earn a profit of 50,000 S.R.

ANSWER 7
Change in Pr ofit 20,000 P / V Ratio 100 100 10% Change in Sales 2,00,000
The amount of Fixed Cost: Contribution of First Year 10% of 7,00,000 = 70,000 + Loss during the year 10,000 = 80,000

Fixed Cost 80,000 B.E.P. 8,00,000 P / V Ratio 10%

Total Sales 8,00,000 B.E.P. in Units 8,000 units S .P. per unit 100

Contd.
Re quired Sales Fixed Cost Desired Pr ofit 80,000 50,000 13,00,000 P / V Ratio 10%

Total Sales 13,00,000 B.E.P. in Units 13,000 units S .P. per unit 100

Question 8
Fixed Expenses = 20,000, Variable Cost per unit 10,

Selling Price Unit = 20, Calculate profit when sales will be 2,00,000.

Answer
P / V Ratio C 10 100 100 50% S 20 50 20,000 80,000 100 Pr ofit ( Sales P / VRatio ) Fixed Expenses 2,00,000

Question 9
Given: P/V Ratio = 30%, Total Turnover = 50,000 S.R. Find out Contribution

Answer:
Contributi on Sales P / V Ratio 50,000 30 15,000 100

Question10
Fixed Expenses = 20,000, Variable Cost per unit 10, Selling Price Unit = 20, Calculate the required sales if profit target of Rs. 60,000 has been budgeted.

Answer 10
C S V 20 10 10 Re quired Sales to earn 60,000 amount of Pr ofit 80,000 8000 units 10
C S V 20 10 10 P / V Ratio C / S X 100 10 / 20 X 100 50% Re quired Sales to earn 60000 amount of Pr ofit 80,000 X 100 1,60,000 50 FP 20,000 60,00,000 P / V Ratio 50%

F P 20,000 60,00,000 C 10

Name of the Student: Class Roll No. Date:

University No.: Marks:10

QUIZ No. 5 COST VOLUME PROFIT ANALYSIS ATTEMPT ALL QUESTIONS

1. For measuring and forecasting the profits of a business the

financial experts use the technique of _______________________. Cost Volume Profit Analysis 2.The Cost volume Profit Analysis is also helpful for the firm in understanding and analyzing the effects on profit with changes in _________ and __________ and ___________of sales. Cost Price volume 3. The B.E.P. is that level of production in a firm where total sales value is more than the total costs. True False False

QUIZ-5

4.Write the correct B.E.P. Equation: SV=F+P 5. What does stand for in Marginal Costing: F= V= C= P/V Ratio = 6. The difference between B.E.P. Sales and Actual Sales is called Margin of Safety. True False False

QUIZ-5
7. Write the formula of Margin of Safety in

percentage form: BEPSales Ans. M arg in of Safety (in % of Sales ) Sales Sales 100 8. In the business, as the margin of safety increase the chances of loss of business decreases. True False True 9. Write the formula for calculation of Sales Volume to earn desired profit: Total FixedCost Desired Pr ofit Ans. Desired Sales (in units )
Contributi on Per Unit

QUIZ-5
10. To improve the Profit Volume Ratio: i. Increase in Selling price ii. Decrease in Variable costs iii. Change in Sales Mix iv. All the above Ans. All the above.

HOME ASSIGNEMENT-5
1.What is meant by the term cost-profit volume analysis? Also explain the Break-even Point. How is it calculated? 2.What do you mean by Profit Volume Ratio? How does it help in profit planning? Explain with appropriate illustrations.