Notes CVP

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COST VOLUME PROFIT ANALYSIS

Learning objectives:- To explain the definition of CVP analysis

- To explain CVP assumptions and limitations

- To determine the break-even point, targetvolume to achieve desired net profit, margin

of safety using equation method and

contribution approach

- To construct break-even chart, contribution

chart and profit-volume chart

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COST VOLUME PROFIT ANALYSIS

Is based on the r/ship between volume and salesrevenue, costs and profit in the short run.

It provides an analysis of what will happen to thefinancial results (level of profits) if activity orvolume fluctuates.

The analysis is useful to plan the futureproduction and sales activity that will enable thefirm to maximize profit and at the same time itenables firm to determine break-even point and

the margin of safety of the firm. This informationis especially important to firm to ensure thesurvival of the firm in short-run and also in long-run.

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Cost Volume Profit Analysis

continues… 

CVP analysis helps managers evaluate the impact

of alternative product pricing strategies on profits.

It can also be useful for evaluating competitors’

pricing strategies and efforts to grow marketshare

It adopts the principle of marginal costingapproach where costs can be divided into fixed

cost and variable cost. Each analysis is applicable in short-run only.

Therefore, firm has to do analysis every timethere is any change in the cost and the volume.

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 Assumptions Of CVP Analysis

Costs can be divided into fixed and variable

elements Unit selling price, unit variable costs, and fixed

costs are known and constant

Fixed costs incurred during the period are charged

as expenses for that period Revenues and costs are linearly related to output

within the relevant range.

Single product is sold or multi-products sold in

accordance with pre-determined sales mix The analysis is not impacted by the time value of

money.

Labour productivity, production technology and

market conditions do not change.ynurli abu bakar

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Limitations Of CVP Analysis 

It is difficult to separate costs can into fixedand variable elements

Unit variable cost and selling price mightchange

Fixed costs remain unchanged within therelevant range but outside relevant range fixedcost might increase or decrease

Labour productivity, production technologyand market condition might change and thiswill affect the CVP analysis

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Break-even Point

This is the level of production and sales at

which a product or service stops losing moneyand becomes profitable.

 At the break-even point profit equals zero.

Once we know the break-even point we canassess the financial viability of a new product

or analyse our current operating

performance.  Total Revenue = Total Costs

Profit is ZERO

Indicates minimum sales volume (units) to

produce and sell to reach break-evenynurli abu bakar

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Methods to determine BreakEven Point 

1. The Contribution Margin method

2. The Equation method

3. The Graphical method

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The Contribution Margin Method 

The contribution margin is total revenue minus total

variable costs.

Similarly, the contribution margin per unit is the selling

price per unit minus the variable cost per unit.

Both contribution margin and contribution margin per unit

are valuable tools when considering the effects of volume

on profit.

Contribution margin per unit tells us how much revenue

from each unit sold can be applied toward fixed costs.

Once enough units have been sold to cover all fixed costs,

then the contribution margin per unit from all remaining

sales becomes profit.

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The Contribution Margin Methodcontinues… 

BEP(units) = Total Fixed costsContribution margin per unit

BEP(RM) = Total Fixed costs 

Contribution margin over sales

OR   BEP(RM) = BEP(units) x Unit Selling Price

o Contribution margin per unit =Unit Selling Price –  Unit Variable Cost

o Contribution margin over sales =

Unit Selling Price –  Unit Var Cost

Unit Selling Priceynurli abu bakar

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The Equation Method

Use a bit of simple maths to answer different

cost-volume-profit questions.

Total revenues are found by multiplying unit selling

price (USP) by quantity sold (Q).

Also, total costs are made up firstly of total fixedcosts (FC) and secondly by variable costs (VC).

Total variable costs are found by multiplying unit

variable cost (UVC) by total quantity (Q).

Any excess of total revenue over total costs will giverise to profit(P).

By putting this information into a simple equation, we

come up with this formulae: 

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The Equation Method continues … 

Sales Revenue = USP x Quantity sold (Q)

Total costs = Total variable costs + fixed costs

Total variable costs = UVC x Quantity sold (Q)

Sales Revenue – Total costs = Net Profit

(USP x Q)  – ( UVC x Q)  – total Fixed Cost =Net Profit

 At BEP; profit is ZERO,(USP x Q) – ( UVC x Q) – total Fixed Cost

= 0 Note: total fixed costs are used rather than unit fixed costs since unit fixed costs

will vary depending on the level of output.ynurli abu bakar

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Example:

Tin Tin Enterprise produces product Ace. The cost

data related to the product is as follows:Unit selling price –  RM20.00

Unit variable cost –  RM12.00

Annual fixed cost –  RM50,000

Annual sales volume –  8000 unitsTargeted profit –  RM20,000

Relevant output range: 6,000 –  12,000 units

Required: Determine the break-even point of Tin Tin

Enterprise in units and value.

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Answer for Tin Tin Enterprise

Answer

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The Graphical Method A CVP graph enables us to visualise the relationships

between sales revenue, total cost, the number of units soldand profit

Sales volume is recorded along the horizontal axis while

sales revenue and total costs are shown on the vertical

axis. The total costs and total revenue lines are plotted on a

graph

The point where the total cost and revenue lines intersect

is the break-even point. The amount of profit or loss at different output

levels is represented by the distance between the total

cost and total revenue lines.

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The Graphical Method

continues… 

The Break-even Chart

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The Graphical Method

continues…  The Contribution Chart

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The Graphical Method

continues… 

The Profit Volume (PV) chart

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 Application Of CVP Analysis Margin of safety (MOS)

- the amount by which actual/budgeted sales may allowto fall without incurring a loss

o MOS units

= Budgeted/Actual Sales units – BEP units

o MOS (RM)= Budgeted/Actual Sales(RM) – BEP (RM)

or

MOS (RM) = MOS (units) x SP p.u.

orMOS (RM) = Profit

C/S ratio

Higher MOS, higher expectation of profit

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 Application Of CVP Analysis continues… 

To determine targetted net profit:o Sales (units) = Total Fixed Cost + Net profit

Unit Contribution Margin

o Sales (RM) = Total Fixed Cost + Net profit

Contribution over sales

Sensitivity Analysiso Changes in total fixed costs

o Changes in unit selling price

o Changes in variable costs

o Changes in sales volume

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Marginal Costing Income Statement

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Company’s Name 

Marginal Costing Income Statement for the year

ended 31 December 20xx

Sales Revenue XXXX

Less: Variable cost of sales 

Direct material XX

Direct labour

XXProduction overhead XX

Selling and distribution overhead XX XXX

Total Contribution Margin XXX

Less: Total fixed costs

Fixed Production overhead XX

Fixed Selling and distribution XX

Fixed Administration XX XX

Net Profit XXX

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List Of Formulae To Remember

Formulae for CVP Analysis 

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Illustration for CVP Analysis

Autogarage Sdn Bhd 

 Jumpershoe Sdn Bhd (high and low

method) 

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