Professional Documents
Culture Documents
on
By
Sanjay Sinha
IV Semester (PT)
Jaipuria Institute of Management
Lucknow
Cost-volume-profit (CVP) analysis
In an expanding market, managers take advantage of fixed costs to generate
profitable growth since additional customers do not add much additional
costs. In this case, a cost structure dominated by fixed costs is a smart
managerial decision.
Total variable costs are considered to be those costs that vary as the
production volume changes. In a factory, production volume is considered to
be the number of units produced.
There are a number of costs that vary or change, but if the variation is not
due to volume changes, it is not considered to be a variable cost. Examples
of variable costs are direct materials and direct labor. Total fixed costs do
not vary as volume levels change within the relevant range. Examples of
fixed costs are straight-line depreciation and annual insurance charges. Total
variable costs can be viewed as a 45o line and total fixed costs as a straight
line. The upward slope of line represents the change in variable costs.
Variable costs sit on top of fixed costs
Breakeven analysis, which tells the sales volume needed to break even,
under different price or cost scenarios
Contribution margin analysis, which compares the profitability of
different products, lines, or services
• Should consider only short- term operations. The short term may
be defined as a period too short to permit facilities expansion or
contraction or other changes that might affect overall pricing
relationships.
Types of Cost :
• Variable Cost: Variable cost per unit remains constant no matter how
many unit are made in the relevant rang of production . Total variable
cost increases the number of units increases.
Examples include :Production, material and labor.
• Semi – variable cost: Semi – variable costs include both fixed and
variable cost elements. Costs may increase in steps or increase
relatively smoothly from a fixed base.
Examples include: Electricity, and telephone.
Algebraic Analysis
Using symbols:
C= F + V
Where:
C = Total cost
F = Fixed cost
V = Variable cost
C =F + Vu * Q
Example of Calculating Variable Cost. Given total cost and volume for
two different levels of production , and using the straight- line assumption ,
you can calculate variable cost per unit:
= C2-C1
Q2-Q1
Where:
C1 = Total cost for Quantity 1
C2 = Total cost for Quantity 2
Q1 = Quantity 1
Q2 = Quantity 2
You are analyzing an offer or a cost proposal . As part of the proposal the
offer or shows that a supplier offer or 5,000 units of a key part for
Rs.60,000. The same quote offered 4,000 Rs.50,000 . What is the apparent
variable cost per unit?
Vu = C2-C1
Q2-Q1
=Rs.60,000- Rs.50,000
5,000-4,000
= Rs.10,000
1,000
= Rs.10
Example of Calculating fixed Cost. If you know total cost and variable
cost per unit for any quantity, you can calculate fixed cost per unit the basic
total cost equation .
You are analyzing an offer or cost proposal . As part of the proposal the
offer of shows that a supplier offered 5,000 unit of a key part for Rs.60,000.
The apparent variable cost is Rs.10 per unit .
C =F + Vu (Q)
Rs.60,000=F+Rs.10(5,000)
Rs.60,000=F+Rs.50,000
Rs.60,000-Rs.50,000= F
Rs.10,000
C = F +Vu(Q)
=Rs. 10,000 + Rs.10 (Q)
You can use this equation to estimate the total cost of any volume in the
relevant range between 4,000 and 5,000 units.
Using the Estimating Equation. Using the estimating equation for the
relevant range, estimate the total cost of 4,400 units.
C= Rs.10,000 + Rs.10(Q)
= Rs.10,000+Rs.10 (4,400)
= Rs.10,000+ Rs.44,000
= Rs.54,000
Graphic Analysis
Introduction to Graphic Analysis.
When you only have two data points , you must generally assume a linear
relationship .When you get more data , you can examine the data to
determine if there is truly a linear relationship .
You should always graph the data before performing an algebraic analysis.
Units Cost
200 Rs.100
500 Rs.175
600 Rs.200
Steps of Graphic Analysis:
There are four steps in using graph paper to analyze cost – volume
relationships:
Step 1. Determine the scale that you will use: Volume is considered the
independent variable and will be graphed on the horizontal axis. Cost is
considered the dependent variable and will be graphed on the vertical axis .
The scales on the two axis do not have to be the same . However, on each
axis one block of the same size on that axis . Each sale should be large
enough to permit analysis – and small enough to permit the graphing of all
available data and anticipated data estimates.
250
200
150
100
50
Cost
100 200 300 400 500 600 700
Units Produced
Step 2. Plot the available cost – volume data: Find the volume given for
one of the data points on the horizontal axis. Draw an imaginary vertical line
from that point . Find the related cost on the vertical axis and draw an
imaginary horizontal line from that point . The point where the two lines
intersect represents the cost for the given volume .(If you not feel
comfortable with imaginary lines you may draw dotted lines to locate the
intersection .) Repeat this step for each data point .
250
200
150
100
50
Units Produced
Step 3. Fit a straight line to the data : In this section of text, all data points
will fall on a straight line . All that you have to do to fit a straight line is
connect the data points . Most analysts use regression analysis to fit a
straight line when all points do not fall on the line.
250
200
150
Cost
100
50
Step 4. Estimate the cost for a given volume : draw an imaginary vertical
line from the given volume to the point where it intersects the straight line
that you fit to the data points . Then move horizontally until you intersect
the cost for the given volume of he item.
250
200
150
100
50
Variable Cost
Line
Cost
Fixed Cost
Line
Units Produced
From the graph , you can estimate that the total cost of 400 units will be
Rs.150.
Graphic representation of Break Even Point
Breakeven Point
The breakeven point can be defined as the point at which sales revenue is
adequate to cover all costs to manufacture and sell the product, but no profit
is earned
= Fixed Cost
Contribution margin per unit
Answer:
Example
1.a Operating income = [Units sold (Selling price –Variable costs)] –Fixed costs
Margin of Safety
The margin of safety (MOS) is the difference between the total sales and the
breakeven sales. It may be expressed in monetary terms or as a percentage
ie. The margin of safety in relation to total sales. It indicates the amount that
sales can decrease before the company will suffer a loss. It is an extremely
valuable guide for the management to check the strength of business.
Example
OR
Margin of Safety = Profit = 10,000 x 100 = Rs.30,000
P/V ratio 33.33