Module-III

Cost-Volume-Profit Analysis
Cost-Volume-Profit Analysis

• Cost-Volume-Profit (CVP) Analysis is a powerful technique for profit planning. It

systematically studies the interrelationship between cost, volume, and profit, helping
management understand how changes in these factors affect overall performance

• These three elements — cost, volume, and profit — are deeply interlinked:

 The cost of production influences the selling price.

 The selling price determines the volume of sales.

 The volume of sales impacts the profit earned.

Cost-Volume-Profit Analysis
CVP analysis helps managers answer key planning questions such as:
 How many units be sold to reach the point where neither profit nor loss will occur?
 How much sales revenue should be generated to earn the target level of profit?
 What is the impact of a decrease or increase in selling price on the profits of the business?
 What is the impact on profits of the additional fixed costs incurred on an advertising
campaign lead to an increase in the number of units sold?
Managerial Relevance of CVP Analysis

• Short-Run Focus: CVP analysis studies the relationship between cost, volume, and profit within a
short-term horizon.

• Capacity Constraint: Only minor operational adjustments are possible; expanding plant capacity is
not feasible in the short term.

• Managerial Insight: Understanding cost behavior enables better cost control and short-term decision-
making.
Assumptions of CVP Analysis

1. Changes in production/sales volume are the sole cause of changes in cost and revenue.

2. All the costs can be accurately identified as fixed costs and variable costs.

3. Both revenue and costs are assumed to vary linearly with output and can be depicted as
straight lines.

4. Selling price per unit, variable cost per unit, and fixed costs are all known and constant.

5. In most cases, business is dealing in single product. In the case of multiple products, the
sales mix is given and constant.

6. The time value of money (interest) is ignored.

Cost-Volume-Profit Analysis
CVP Analysis

Selecting the Choosing among

Analyzing Setting Selling mix of products marketing
Prices to sell strategies

Effects of
Effects of Effects of
Changes in
Changes in Changes in
Selling
Costs on Volume on
Prices on
Profits Profits
Profits
Basic Terms of CVP Analysis
• Contribution/Contribution Margin: It refers to the excess of sales over variable costs. It
indicates the amount contributed by sales towards recovering the fixed costs of the business
and thereafter providing for profits.
• Contribution per unit can be calculated as follows:
Contribution per unit = Selling price per unit – Variable cost per unit
• The total contribution can be computed as shown below:
Total Contribution (in amount) = Total Sales Revenue – Total Variable Cost
OR
= Number of units × Contribution per unit
• Further, we can say that:
Total Contribution (in amount) = Total Fixed Cost + Total Profit(or Loss)
Contribution Margin

• Prob. 1: Suppose a company sells 50,000 units of a product at ₹20 per unit. Production cost includes
variable cost of ₹ 12 per unit and fixed cost of ₹ 3,00,000. Calculate the contribution margin.
 Contribution Margin Ratio
• It indicates the proportion of sales revenue available to recover fixed costs and once the fixed cost
is recovered, then provides for profits.

• The Contribution Margin Ratio (CMR) is also known as:

• Contribution Margin to Sales Ratio (C/S Ratio)

• Profit–Volume Ratio (P/V Ratio)

• It is calculated as follows:

CM Ratio =

Or

CM Ratio =
Contribution Margin Ratio

• CM Ratio =

Or

• CM Ratio =

Or

• Change in Profit = Change in Sales Revenue × CM Ratio

Prob. 2: Calculate total contribution in the following independent situations:

i. Sales ₹ 10,00,000; Variable Cost ₹ 7,70,000.

ii. Total Fixed Cost ₹ 50,000; Total Operating profit ₹ 1,00,000.

iii. P/V Ratio 70%; Sales Revenue ₹ 1,00,000.

Variable Cost Ratio

• Variable cost ratio refers to the proportion of sales revenue used to cover variable costs.

• VC Ratio =

Or

• The sum of the Variable Cost Ratio and the P/V Ratio is always equal to one as explained below:

P/V ratio =
Prob. 3: Toussant Company produces and sells a single product. The following information
relates to operations for the current year:
Particulars Details
Units sold 20,000 units
Selling price per unit 120
Variable cost per unit ₹ 90
Total fixed cost ₹ 250,000

Required:
1. Prepare an Income Statement using the Contribution Margin Format.
2. Calculate the following: (a) Unit Contribution Margin, (b) Contribution Margin Ratio (CMR)
3. Determine the change in operating income if sales volume increases by 3,000 units, assuming
that the selling price, variable cost per unit, and fixed costs remain unchanged.
Break-Even Point

• The break-even point is the point where there is no profit or loss.

• It is the level of sales at which total revenue is equal to total cost.

• It is calculated as follows:

Break-Even Point (in units) =

Break-Even Point (in rupees) =

Break-Even Point
Prob. 4: Baker Corporation provides the following cost and revenue data for the current year:
Particulars Amount (₹)
Fixed costs 90,000
Selling price per unit 25
Variable cost per unit 15

Required: Compute the Break-even Point for Baker Corporation in units and in rupees.
Profit Planning using CVP Analysis
Target Profit
• The sales required to earn a target or desired amount of profit is determined by modifying the break-
even equation as follows:

• Sales (Desired Sales in units) =

• Sales (Desired Sales in rupees) =

Target Profit
Prob. 5: The following cost and revenue information pertains to Waltham Co. for the current year:
Particulars Amount (₹)
Fixed Costs 200,000
Selling Price per Unit 75
Variable Cost per Unit 45

Required:

Calculate the sales volume (in units) required for Waltham Co. to earn the target profit of ₹ 1,00,000.
Prob. 6: Zeom Plastic Company makes plastic buckets. There books reveals the following data:
Particulars Amount
Variable cost per bucket ₹ 20
Fixed Cost ₹ 50,000 for the year
Capacity 2,000 buckets per year
Selling price per bucket ₹ 70

Find:

i. Break-even point in units.

ii. The number of buckets to be sold to get a profit of ₹ 30,000.

iii. What would be the selling price to maintain the profit per bucket same as at (ii) above, the company
can manufacture 600 buckets more per year with an additional fixed cost of ₹ 2,000.
Effects of Changes in Selling Price and Costs on Break-even
Point
Graphical Presentation of Cost-Volume-Profit Analysis

• The graphical method visually shows how changes in sales volume affect costs, revenue, and profit.

• It helps in identifying:

• The Break-Even Point (BEP) — where total cost equals total revenue.

• The Profit Area (beyond BEP) and the Loss Area (below BEP).
• Let us consider the following data to prepare the Cost-Volume-Profit Chart.
Total fixed Costs ₹ 1,00,000
Unit selling price ₹ 50
Unit variable price ₹ 30
Unit contribution margin ₹ 20
Cost-Volume-Profit Analysis
Profit-Volume Analysis

• It is a managerial accounting technique that studies the relationship between profit and sales volume,
showing how changes in sales affect the level of profit.
• Let us consider the following data to prepare the Cost-Volume-Profit Chart.
Total fixed Costs ₹ 1,00,000
Unit selling price ₹ 50
Unit variable price ₹ 30
Unit contribution margin ₹ 20
Profit-Volume Analysis
Prob. 7: Dee Ltd., a manufacturer of sporting goods, produces and sells binoculars at a selling
price of $140 per unit. The variable cost per unit is $100, and the total fixed costs amount to
$12,00,000.

Required:

1. Calculate the break-even point (in units) for binoculars.

2. Determine the sales volume (in units) required to achieve a target operating income of
$400,000.

3. Prepare a Cost–Volume–Profit (CVP) Chart illustrating the break-even point for binoculars.
Income Tax in CVP Analysis
• After-tax profit (Net Profit) can be calculated by:
Net Profit = Operating Profit * (1-Tax Rate)

• Net income can be converted to operating income for use in the CVP equation
Operating Profit =

Note: the CVP equation will continue to use operating profit. We’ll use this conversion
formula to obtain the Operating Profit value when provided with Net Profit.

• Sales (Desired Sales in units) =

• Sales (Desired Sales in rupees) =

Prob. 8: The Grand Plaza operates two restaurants that are open 24 hours a day. The following
information pertains to the operations of both restaurants:
Particulars Amount ( ₹)
Total Fixed Costs (per year) 10,00,000
Average Sales Revenue per Customer 20
Average Variable Cost per Customer 8
Income Tax Rate 30%
Target Net Profit 3,50,000
Required:
1. Compute the revenues required to achieve the target after-tax profit.
2. Determine the number of customers required to:
a). Break-even, and
b). Earn a net profit of ₹3,50,000.
3. Compute the net income if the number of customers served is 2,00,000 in a year.
Margin of Safety
• If budgeted revenues are above the breakeven point; how far can they fall before the breakeven point

is reached.

• Margin of Safety (MOS)/(M/S) indicates the amount by which sales can fall before a firm starts

incurring a loss.

• The MOS(M/S) can be calculated as:

MOS (in units) = Actual Sales (in units) – Break-Even Sales (in units)

MOS (in rupees) = Actual Sales (in rupees) – Break-Even Sales (in rupees)

MOS (in units) =

MOS (in rupees) =

MOS Ratio =
Use of CVP Analysis for Decision Making

• CVP analysis helps managers understand how changes in selling price, costs, and volume affect
operating income.

• It is a tool for making informed pricing, cost control, and production decisions.

• Managers can test how lower prices with higher sales or higher prices with lower sales impact
profitability.

• CVP analysis links cost, price, and profit to support strategic decisions.

• It helps managers identify the most profitable balance between price, volume, and cost structure.
Sensitivity Analysis
• It is an extension of Cost-Volume-Profit (CVP) Analysis that examines how changes in key variables — such as selling price, cost,
or sales volume — affect profit.

• It answers, “What if?” questions:

• What happens to profit if price decreases?

• What happens if variable cost rises or sales volume falls?

• “What” happens to profit “if”:

• Selling price changes

• Volume changes

• Cost structure changes

• Variable cost per unit changes

• Fixed costs change

Operating Leverage

• Operating Leverage measures how sensitive a firm’s operating income (profit before interest and
taxes) is to a change in sales volume.

• Operating Leverage is the degree to which a firm can increase operating income by increasing sales.

• It describes the effects that fixed costs have on changes in operating income as changes occur in units
sold and contribution margin.

• Operating Leverage =
Estimating Changes in Operating Income through Operating
Leverage
• Operating leverage can be used to measure the impact of changes in sales on operating income.

• Using operating leverage, the effect of changes in sales on operating income is computed as follows:

• Percentage Change in Operating Income = Percentage Changes in Sales × Operating Leverage

Effects of Sales Mix on CVP Analysis

• Sales Mix is the quantity or proportion of various products or services that constitute a company’s
total unit sales. It is often the case that the various products or services have different contribution
margins.

• Up to this point, we’ve assumed a single product; more realistically, we’ll have multiple products with
different costs and different margins.

• We can use the same formula in our CVP calculations but must use a weighted-average contribution
margin for the products.

• This technique assumes a constant mix at different levels of total unit sales.
Contribution Margin Vs. Gross Margin
• Gross Margin = Revenue – Cost of Goods Sold

• Contribution Margin = Revenue – All Variable Costs

• Gross Margin measures how much a company charges for its products over and above the
cost of acquiring or producing them.
• Contribution Margin indicates how much of a company’s revenue is available to cover fixed
costs.