Cost Volume Profit Analysis

By Ghanendra Fago
For MBA, KUSOM

By Ghanendra Fago (M. Phil, MBA) For 1

KUSOM
 Cost-Volume-Profit Analysis
 Study of relationship between costs, volume, and
profits.
 If 10% volume changed, what is the expected
change in profit and cost?
 If 10% cost changed,
 If volume and cost changed, what is the expected
change in profit?
 Break even analysis – A techniques of CVP
analysis

By Ghanendra Fago (M. Phil, MBA) For KUSOM 2

 Use of CVP Analysis
 What level of sales is needed to avoid the losses?
 What sales volume is needed to earn a target profit?
 What would be the effect on profits if we reduce our selling
price and sell more units?
 What sales volume is required to meet the additional fixed
charges arising from an advertising campaign?
 What will be the effect on the profit, where sales mix is
changed?
 What will be the new-break-even point when there is change
in prices, costs, volume, and sales mix?
 Which product or product mix is most profitable?
 Which product or product mix should be discontinued or
not?
By Ghanendra Fago (M. Phil, MBA) For KUSOM 3
 Assumptions of CVP Analysis i.e
Certainty Analysis
 Costs can be divided into fixed and variable elements
 Fixed costs will remain constant
 Variable cost per unit and selling price remain constant.
 A company produces a single product. If multiple
product mix remains constant.
 Production equals to sales i.e. there is no change in
inventory.
 No change in capacity and productivity.

By Ghanendra Fago (M. Phil, MBA) For KUSOM 4

 Break Even analysis

 Break-even analysis is a technique of representing

and studying the inter-relationship of the three basic
components of CVP: cost, volume and profit.
 The break-even analysis determines a relationship
between the revenues and costs with respect to
volume.
 Break-even analysis is always taken as an important
part of profit planning as it gives the planner many
insights into the data with which he or she is working.
 It is a point where the profit is zero as the total
revenues are equal to total costs. In other words, it is
that level of activity (in units or in Rs.) at which
revenue equals cost.
By Ghanendra Fago (M. Phil, MBA) For KUSOM 5
 Methods of CVP Analysis

 Graphic approach
 Income statement Approach
 Contribution margin or Formula approach
 Equation approach

By Ghanendra Fago (M. Phil, MBA) For KUSOM 6

 Graphic Analysis of Break Even Point
Sales revenue

250 Total cost

Profit
Cost,
Price, 200
Profit (in
000 Rs.) BE Point
150
Variable
100 Cost

Loss
50
Fixed Cost

50 100 150 200 250

0 Margin of safety
Quantity in units (in 000 units)

By Ghanendra Fago (M. Phil, MBA) For KUSOM 7

 Income Statement Approach
Particulars Amounts %
Sales 10,000 units @ Rs10 per unit Rs. 100,000 100%
Less: Variable cost @ Rs. 4 per unit 40,000 40%

Contribution Margin @ Rs. 6 per unit 60,000 60%

Less: Fixed costs 50,000

Net profit 10,000

By Ghanendra Fago (M. Phil, MBA) For KUSOM 8

 Variable Income Statement
Sales in units 56,250
Sales revenue @Rs 20 11,25,000
Less: variable cost @Rs 12 6,75,000
Contribution margin @Rs 8 4,50,000
Less: fixed cost 4,50,000
Net income before tax 0

By Ghanendra Fago (M. Phil, MBA) For KUSOM 9

 Contribution Margin Approach Or
Formula Approach
 The approach uses the concept of contribution
margin and contribution margin ratio.
 To find out the number of units to be sold to break-
even, the fixed cost can be divided by contribution
margin contributed by each unit sold.
 Break Even Point (in units)
= Fixed cost/CMPU = ….. units
= Fixed cost/PV ratio = ….. in Rupees

By Ghanendra Fago (M. Phil, MBA) For KUSOM 10

 Formulae of Cost Volume Profit Analysis

1. Contribution Margin per Unit (CMPU)

= Selling Price per unit – Variable cost per unit
= Selling Price per unit x PV ratio
= Difference in Profit/difference in sales units
= Profit/margin of safety units
2. Profit Volume (Contribution margin) Ratio
= 1 –CV ratio or
= 1- VCPU/SPPU
= Difference in Profit/difference in sales revenues
= 1- Difference in costs/ difference in sales
= Profit/margin of safety rupees
3. Break Even Point (in units)
= Fixed cost/CMPU = … units
= FixedBycost/PV
Ghanendra ratio
Fago (M.= ….in
Phil, MBA)Rupees
For KUSOM 11
4. Required sales to earn desired profit:
Target sales volume to earn profit before tax in rupees
= FC+ before tax target profit/Contribution margin ratio

Target sales volume to earn profit before tax in units

= FC+ before tax target profit/Contribution margin per unit

Target sales volume to earn after tax (in rupees)

= FC+{(desired profit after tax) / (1-t)}/Contribution margin
ratio

Target sales volume to earn after tax (in units

= FC+{(desired profit after tax) / (1-t)}/Contribution margin
per unit

By Ghanendra Fago (M. Phil, MBA) For KUSOM 12

5. Profit on Sales
= Sales – Variable Cost – Fixed Cost
= (Sales Rs.  P/V Ratio) – Fixed Cost
= (Sales Units  CMPU) – Fixed Cost
= Margin of Safety  CMPU
6. Margin of Safety
= Actual Sales – Break Even Sales
= Margin of Safety/Actual sales
= Profit/CMPU or PV ratio
7. Sales to earn equal profit by two alternative
=Differences in fixed costs/difference in PV ratio or CMPU

By Ghanendra Fago (M. Phil, MBA) For KUSOM 13

 Multi Products/Sales Mix

Overall BEP (in Rs.) =Total fixed costs/WAPV ratio =Rs….

Overall BEP (Units) = Total fixed costs/WACMPU = Units
Calculation of weighted average CMPU

Product Sales Sales Mix CMPU Contribution

units
X    
Y    
Weighted Average CMPU 

By Ghanendra Fago (M. Phil, MBA) For KUSOM 14

 Weighed Average profit Volume Ratio PV ratio

Product Sales In Sales Mix PV Ratio Contribution

amount (PV ratio  Sales Mix)
X    

Y    

Weighted Average PV ratio 

By Equation:
Sales revenues = Fixed costs + variable costs + profit
In units: x = FC + VC + Profit
or, x = FC + VC ratio (x) + profit
In Rs: Sales price (x) = FC + VC + profit
or, sales price (x) = FC + VC rate (x) + profit

By Ghanendra Fago (M. Phil, MBA) For KUSOM 15

 Cost Volume Profit Analysis Under Changing
Situations - Sensitivity Analysis
• Sensitivity analysis is the measurement of
responsiveness in outcome with the change in
determination variables.
• As the goal of a business, enterprise is to maximize
profits.
• Profits are the excess of revenue over the total costs
• To measure the sensitivity of CVP factors, the impact of
certain percentage of change in volume, price, or cost
factor on net profits must take into consideration.

By Ghanendra Fago (M. Phil, MBA) For KUSOM 16

 Change in selling price
The change in selling price will affect the profit
volume ratio and thus the break-even point. An
increase in selling price will increase the PV ratio
and will lower the break-even point. The reverse
will have opposite effect i.e., decrease in selling
price will reduce PV ratio and it results in to
higher BEP.

By Ghanendra Fago (M. Phil, MBA) For KUSOM 17

Change in variable costs

 The change in variable costs has an opposite

reaction to the PV ratio i.e. decrease in variable cost
result in increase in PV ratio, whereas increase in
variable cost shall result in decrease in the PV ratio.
A decrease in PV ratio results into higher BEP and
reduced profit and vice-versa.

By Ghanendra Fago (M. Phil, MBA) For KUSOM 18

 Change in fixed costs

A change in fixed cost does not have any

effect on the PV ratio but it affects the break-
even point and ultimately the profit. A
decrease shall lower the BEP and increase
the profit. Any increase pushes the break-
even point and reduces the profits.

By Ghanendra Fago (M. Phil, MBA) For KUSOM 19