Cost Volume Profit Analysis

The relationship between cost, sales and profit is shown by cost volume profit analysis. A cost
volume profit analysis is helpful in profit planning and control, management decision, cost
control and budgeting etc. CVPA can be regarded as a sophisticated method or analytical tool
used in management. The use of this method helps in determining the different levels of product
or sales to avoid losses, to earn a desired net profit and so on. The cost volume profit relationship
helps management to find out right solution for following questions:

 What sales volume is needed to break even and to earn a desired profit?

 How will the change in selling price affect the profit position of the company?

 How will the change in cost affect profit?

 Which product or product mix is profitable?

 Which product or operation of a plant should be discontinued?

 What will be new break even sales if there is change in fixed and variable cost? etc.
Five important factors influence cost volume profit analysis are:
Fixed Cost, Variable Cost, Selling Price, Volume of Sales or Level of Sales Activities and
Mixture of the types of products sold.
Break Even Analysis
The breakeven point is used under breakeven analysis. Break-even point is the level of activity
where total costs are equal to total sales. It is a point of no profit and no loss. If the sales or
production is higher than break-even volume, there will be profit. In the same way if the sale is
less than break-even sales, there will a loss. According to BEP all costs can be classified into
fixed and variable cost, selling price & fixed cost will remain constant and the levels of
production and sales remain unchanged during the period.
Graphic Presentation Total Sales
Y Total Cost
profit
B E Point Variable Cost
Cost & Sale
loss
Fixed Cost

Margin of Safety X
Output
Importance of BEP
The breakeven point is helpful to management of forecasting, evaluating managerial efficiency
and decision making.
The BEP is used in determining the following:

 The requirement of the sales department that justify a proposed investment in plant
expansion

 The effect of increases and decreases in sales volume

 The probable cost per unit of manufactured goods at various production levels

 The evaluation of changes in production methods

 The planning of profit objectives

Contribution Margin is the difference between Sales and Variable Costs. The excess of sales
over variable costs can be used to contribute toward meeting fixed costs achieving a profit for the
period.
Advantage of Cost Volume Profit Analysis
CVPA helps management in a number of ways, they are as follows:

 Calculation of profit from a budgeted sales volume and sales volume to break-even

 Calculation of sales volume to produce desired profit

 Effect of changes on price, costs and profits

 Determination of new BEP for changes in cost and selling price

 Measurement of effect of changes in profit factors

 Determining the optimum sales mix and capacity

 Make or buy decision on sub-assemble or part

 Long term decision on continuance or discontinuance of products

 It helps in fixation of selling price

 It is helpful in cost control

 It assists the management in profit planning and in decision making etc.

Limitation of Cost Volume Profit Analysis

 The assumption that fixed cost always remains constant is not true. It may be increased
when production or operation technique is changed.

 The assumption that the productions and sales level should be equal is another drawback
of CVPA.
 It is not easy to forecast future break-even points at various sales volumes.

 According to the assumption of CVPA, total cost can be divided into fixed and variable
cost only. There are other costs, which are neither fixed nor variable, i.e. semi variable or
fixed cost.

 The assumption that the variable cost (direct labour) remain constant in per unit cannot be
entirely true, because any change in production volume will have a direct effect on
labour. If the organization decides on a temporary shutdown of operations, and wants to
retain its highly experienced and skilled labour during the shutdown period, the fluctuate
nature of direct labour is changed.

Formulas:
 CMPU = Contribution Margin per Unit = SPPU – VCPU

 P/V Ratio = Profit Volume Ration = Contribution Margin Ratio= 1- V/S or CM/S

 V/V Ratio = Variable Cost Volume Ration = 1 – P/V Ratio or V/S

Different in Profit

 P/V Ratio =
Different in Sales
Fixed Cost

 BEP in Units =
CMPU
Fixed Cost

 BEP in Rs.=
P/V Ratio
Cash Fixed Cost

 Cash BEP in Units =

CMPU
Cash Fixed Cost

 Cash BEP in Rs.=

P/V Ratio
(Cash Fixed Cost = Total Fixed Cost – Depreciation)
 Profit

 Margin of Safety =
P/V Ratio
Actual Sales – BE Sales

 Margin of Safety Ratio =

Actual Sales

 Margin of Safety = Actual Sales – BE Sales

Fixed Cost + Desired Profit

 Required Sales for Desired Profit in Units =

CMPU
Fixed Cost + Desired Profit

 Required Sales for Desired Profit in Rs.=

P/V Ratio
Fixed Cost + Desired Profit after Tax

 Required Sales for Desired Profit in Units = 1 - Tax

CMPU
Fixed Cost + Desired Profit after Tax

 Required Sales for Desired Profit in Rs.= 1 - Tax

P/V Ratio

 Profit if Sales in Rs. = (Sales Rs. x P/V Ratio) – Fixed Cost

 Profit if Sales in Rs. = (Actual Sales Rs. – BE Sales Rs.) x P/V Ratio

 Profit if Sales in Units = (Sales Units x CMPU) – Fixed Cost

 Profit if Sales in Units = (Actual Sales Units – BE Sales Units) x CMPU

Fixed Cost

 Required Sales for fixed percentage of Profit on Sales =

SPPU – VCPU - PPU
(PPU = Profit per Unit)
(Sales – Variable Costs = Contribution Margin – Fixed Cost = Profit)
Problems:
1. If SPPU = Rs.10, VCPU = Rs.6, Fixed Cost = Rs.40000
Find out: …………………
2. If SPPU = Rs.20, VCPU = Rs.12, Fixed Cost = Rs.80000, Find out:
a. BEP Units and Rs.
b. Profit if Sales Amount is Rs.350000
c. Required Sales Units if Desired Profit of Rs.32000
d. Required Sales Rs. if Desired Profit after Tax is Rs.20000, if tax rate is 50%
e. Margin of Safety if Sales is Rs.300000
f. New BEP if SPPU increased by Rs.3 and VCPU is decreased by Rs.1
g. Draw a CVP chart for the company, showing output on horizontal axis. Identify the
break-even point and the amount of profit before tax when the output is 15000 units.
3. The selling price for 100 meters is Rs.1500. The variable cost for 100 meters is Rs.1000
and fixed costs are expected to be Rs 75000 up to the capacity of 20000 meters.
Find out:
a. BEP in units and Rs.
b. Prepare Income Statement at BEP
c. Prepare CVP chart. Use 20000 meters as the maximum numbers of sales units and Rs.
300000 as the maximum number of rupees.
4. The selling price per unit is Rs.25. The variable cost per unit is Rs.15 and fixed costs are
expected to be: Depreciation Rs.60000, Supervision (for every 10000 units) is Rs.10000
and Repairs (for every 7500 units) is Rs.20000. Find out: BEP in units and Rs.
5. Income Statement of a Limited Company is as follows:
Production and Sales Units: 10000
Sales Revenue @ Rs.20 per unit Rs.200000
Less: Variable Cost @ Rs.12 per unit Rs.120000
Contribution Margin Rs.80000
Less: Fixed Cost Rs.50000
Net Income before Tax Rs.30000
Required:
a. BEP in Units and Rs.
 b. Sales Units to earn Rs.60000 after tax (Tax Rate 40%)
c. Safety Margin Ratio
d. Sales Units to earn Profit per Unit Rs.4
6. If Sales Units = 10000, Sales Revenue = Rs.200000, Variable Cost = Rs.100000, Fixed
Cost = Rs.60000, Find out: BEP Units and Rs. if
a. Decrease of 10% in selling price
b. Increase in 10% variable cost
c. Increase of sales volume by 1000 units
d. Increase of Rs.10000 in fixed cost
7. The given information of a trading concern for the past two years is as under
Year Sales Net Profit
2009 Rs.500000 (Rs.15000)
2010 Rs.800000 Rs.45000
Required:
a. P/V Ratio (b) Fixed Cost (c) BEP in Rs. (d) Sales required to earn a desired profit of
Rs.75000
8. The given information of a trading concern for the past two years is as under
Year Sales Profit
1st Year Rs.400000 Rs.50000
2nd Year Rs.900000 Rs.175000
Required:
a. BEP in Rs.
b. Sales required to earn a desired profit after tax of Rs.84000 at 40% tax rate
COST VOLUME AND PROFIT ANALYSIS

BEP IN MULTI PRODUCTS

Calculate the break even sales from the following data for a company producing three products:
Product Sales (Rs.) Variable Costs (Rs.)
A 10,000 6,000
B 5,000 2,500
C 5,000 2,000
20,000 10,500
Total fixed costs amounts to Rs. 5,700
[Ans: Combined BEP: Rs. 12,000]

BEP UNDER MULTI PRODUCTS

A firm has two products, X and Y. some data relating to them are given below.
Product Variable Cost Selling Price
X Rs. 80 per unit Rs.100 per unit
Y Rs. 60 per unit Rs. 100 per unit

Fixed expenses of the firm is Rs. 5,000

The sales of units of product X is three times that of units of product Y.
Required:
Compute break even for the overall company and individual products too.
[Ans: Rs. 20,000; Rs. 15,000 and Rs. 5,000]

BEP UNDER MULTI-PRODUCT AND SELECTION OF PROFITABLE SALES MIX

[Ans: (1)50,000 units; 30,000 units and 20,000 units (2) 43,750 units; 17,500 units 26,250 units]

BEP OF MULTI-PRODUCTS
Beltronic Pvt. Ltd. Company produces two products- Lovely and Beauty. The company’s annual
sales and expenses were as follows:
Products Lovely Beauty Total
Sales (units) 20,000 30,000 50,000
Sales (Rs.) 3,00,000 6,00,000 9,00,000
Less: Variable costs
Material 60,000 180,000 240,000
Labour 80,000 120,000 200,000
Variable manufacturing overhead 20,000 90,000 110,000
Variable selling & administrative 40,000 60,000 100,000
Total Variable cost 200,000 450,000 650,000
Contribution margin 100,000 150,000 250,000
Less: Depreciation fixed cost 40,000 50,000 90,000
Margin for joint fixed cost 60,000 100,000 160,000
Less: Joint fixed cost 90,000
Net income 70,000

Required:
 Weighted average CMPU and PV ratio.
 Company’s BEP in units and in Rs.
[Ans: (1) Rs. 5 and 5/12 (2) 36,000 units & Rs. 648,000]

BEP UNDER SALES MIX

Pokhara Food Ltd. Produces two different types of food. The financial data relating to these
products are presented below:
Details Food A Food B Total
Sales in boxes 40,000 20,000 60,000
Sales revenue Rs 40,00,000 Rs 20,00,000 Rs 60,00,000
Less: Variable costs 2,800,000 8,00,000 3,600,000
Contribution margin 1,200,000 1,200,000 24,00,000
Less: Fixed Cost
Departmental fixed costs 400,000 500,000 900,000
Joint fixed cost 300,000
Total fixed cost 1,200,000
Net profit before tax 1,200,000

Required:
 What sales volume in units and rupees keep the company in break-even?
 Sales units to obtain Rs.1800000 profit
Profit if Sales is Rs.8000000
Cases
1. Punjab Textiles is known across the globe for its high quality fabrics. The compnay until 2009
has been successful in targeting its products to reputed companies of readymade garments in
different parts of Europe. Upto 2009 the company has not only been successful in exporting
largets volume of fabrics from India to Europe but also in making its presence felt in this context.
Despite all this, the company is facing an intense competition in European market from textile
exporters of Bangladesh and Indonesia who have entered this market recently. Consequently,
sales and net income of the company for the past few years have been declining. During the year
2011, the company has managed marginal sales revenue by selling just 6200 units of ‘Khadi’ and
5800 units of ‘Denim’ and consequently both products left very little as margin of safety.

To meet the growing demands of competition and reverse the trend of declining sales, the
strategic committee of the company decided in favour of reducing the selling price by 15% and
10% for ‘Khadi’ and ‘denim’ respectively. It is believed that the reduction in selling price would
increase the sales of ‘Khadi’ and ‘Denim’by 25% and 30% respectively. The existing selling
price of ‘Khadi’ and ‘Denim’ is Rs.1500 and Rs.1200 per unit respectively.

The Strategic Committee of the company has taken these measures after analyzing the folowing
details about variable costs and fixed costs for the year 2011 submitted by the accounting
department of the company:

Cost Statement Showing Variable Costs Per Unit

Particulars Khadi (Rs.) Denim (Rs.)

Materials 500 450

Wages 300 200

Expenses 150 90
 Total 950 740

Cost Statement Showing Fixed Cost

Particulars Khadi (Rs.) Denim (Rs.)

Production Cost 1500000 1250000

Administrative Cost 630000 410000

Distribution Cost 1270000 840000

Total Fixed Cost 3400000 2500000

The Strategic Committee is also willing to take any measure that would ensure optimum use of
the production capacity. Even it is considering a proposal to produce only one type of product if
it promises to generate maximum sales revenue.

Required:

a. Examine the impact of price reduction on company’s sales and profits. Determine the break
even point and margin of safety for both products after making reductions in their prices.

2. The following information of two companies is provided:

Company A Company B

Sales Rs. 600000 600000

Less;

Variable Cost 240000 300000

Fixed Cost 300000 240000

Total Cost 540000 540000

Profit 60000 60000

Required: Compare and evaluate the economic character of two companies