COST VOLUME PROFIT ANALYSIS (CVP)
It is also called Break Even Analysis. In CVP analysis, we consider the effect of change in volume on cost, sales and profit.
It is based on concept of Marginal Costing.
To understand concept of CVP, we analyse the following equation. For this purpose we make following assumptions:
1. Selling price per unit is constant (same)
2. Variable cost per unit is constant (same)
| Sales – Variable Cost = Contribution = Fixed Cost + Profit | ||
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| Sales and Variable Cost is taken Per Unit | | Fixed Cost and Profit is taken In Total |
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| So in CVP, to cover our Fixed Cost and Profit in Total (Total Contribution), we work on Per Unit Sales and Variable Cost (Unit Contribution) and this is work of CVP J | ||
Unit contribution = Selling per unit – Variable Cost per unit
Total contribution = Fixed cost + Profit
Total contribution = Fixed Cost (if profit is zero)
Total contribution = Fixed Cost
Total contribution / Volume = Fixed Cost / Volume
Unit contribution = Fixed cost per unit
Total contribution = Unit contribution x Volume (Required units)
BREAKEVEN ANALYSIS
Breakeven point is calculated in terms of units but it may be calculated in terms of Sales (revenue). To calculate breakeven point in terms of sales, we multiply breakeven point in units to selling price.
| Required Unit (for covering cost) | = | Total contribution | = or | Fixed Cost | = | Break Even point (unit) |
| Unit contribution | Unit Fixed Cost |
Break Even Point = Fixed Costs / Unit contribution
Total Contribution = Contribution Target = Fixed Cost + Target Profit
Example
Selling Price = $15 / unit
Variable cost = $6 /units
Fixed Cost = $45,000
Required:
How many units must be produced to?
1. Breakeven
2. Generate profit of $30,000
Solution:
1. Breakeven
Breakeven = Fixed Cost / (Selling cost – Variable cost)
Breakeven = 45,000 / (15-6)
Breakeven = 5,000 units
2. Generate profit of $30,000
Total contribution = Fixed cost + Profit
Total contribution = $45,000 + $30,000 = $75,000
Volume = Total contribution / Unit contribution
Volume = $75,000 / $9 = 8,334 units
MARGIN OF SAFETY
It is difference between budgeted and breakeven sales. It calculated / represented in:
1. Units
2. Revenue
3. %age of budget
Example
Contribution / unit = $10 / unit
Fixed Cost = $50,000
Budgeted Sales = 8,000 units
Solution:
Breakeven point (units) = Fixed Cost / Contribution per unit
= $50,000 / $10 per unit
= 5,000 units
Margin of safety = Budgeted sales – Breakeven sales
= 8,000 units – 5,000 units
= 3,000 units
% age of Budgeted = 3,000 units / 8,000 units x 100 = 37.5%
C/S RATIO (P/V RATIO)
C/S Ratio – Contribution to Sales Ratio
P/V Ratio – Profit to volume Ratio
Example
Variable Cost = £4/unit
Selling Price = £10/unit
Required:
C/S Ratio?
Solution:
Contribution / unit = Selling Price – Variable Cost
= £10 - £4
=£6/unit
C/S Ratio = Contribution / Selling Price
= £6 / £10
= 0.6 or 60%
Why do we calculate C/S Ratio?
C/S Ratio is calculated when we directly want to know breakeven in sales (revenue). We don’t need to calculate breakeven in units for calculation of breakeven in sales.
| Breakeven point (in Revenue) = | Target Contribution |
| C/S Ratio |
Example
Selling price = £20/unit
Variable coat = £12/unit
Fixed cost = £80,000
Solution:
Unit contribution = Selling price per unit – Variable cost per unit
= £20 - £12
= £8
C/S Ratio = Unit contribution / Selling price
= £8 / £20
= 0.40 or 40%
Breakeven point (Revenue) = Target contribution / (C/S Ratio)
= £80,000 / 0.40
= £200,000
BREAKEVEN POINT ON GRAPH / CHART
Selling price per unit = £10
Variable cost per unit = £3
Fixed cost = £35,000
Budgeted output = 10,000 units
Selling Price (for budgeted output) = Selling price per unit x budgeted output
= £10 x 10,000 units
= £100,000
Variable Cost (for budgeted output) = Variable cost per unit x Budgeted output
= £3 x 10,000 units
= £30,000
Total output = Fixed Cost + Variable Cost
= £35,000 + £30,000
= £65,000
Contribution = Selling price – Variable Cost
= £100,000 - £30,000
= £70,000
CONTRIBUTION BREAKEVEN CHART
PROFIT VOLUME CHART
To draw Profit Volume Chart, we assume that:
1. We have no revenue;
2. We have no variable cost;
3. We only have fixed cost;
Fixed Cost = £35,000
Selling price per unit = £10
Variable cost per unit = £3
Unit contribution = Selling price per unit – Variable cost per unit
= £10 - £3 = £7
Breakeven point = Fixed cost / Unit contribution
= £35,000 / £7 = 5,000 units
