Chapter 16

Volume-Cost-Profit Analysis
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-1

VOLUME-COST-PROFIT ANALYSIS

BREAK-EVEN ANALYSIS

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-2

Volume-Cost-Profit Analysis
The cost-volume-profit (CVP) analysis is a tool to show the relationship between various ingredients of profit planning, namely, unit sales price (SP), unit variable cost (VC), fixed costs (FC), sales volume, and sales-mix (in the case of multi-product firms).
The crucial step in this analysis is the determination of break-even point (BEP), which is defined as the sales level at which the total revenues equal total costs. It is the level at which losses cease and beyond which profit starts.
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-3

Break-Even Point
BEP can be determined by the following two methods (1) Algebraic Methods (2) Graphic Presentation a) Contribution margin a) Break-even chart approach b) Equation technique b) Volume-profit graph

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-4

1(a) Contribution Margin Approach

Contribution margin is the excess of unit sale price over unit variable cost Example 1: How many ice-creams, having a unit cost of Rs 2 and a selling price of Rs 3, must a vendor sell in a fair to recover the Rs 800 fees paid by him for getting a selling stall and additional cost of Rs 400 to install the stall? The answer can be determined by dividing the fixed cost by the difference between the selling price (Rs 3) and cost price (Rs 2). Thus BEP (units) = Fixed cost (Entry fees + Stall expenses) (Sales price Unit variable cost) Fixed costs Contribution margin (CM) per unit

(Rs 800 + Rs 400)/(Rs 3 Rs 2) = 1,200 units BEP (units) =

BEP (amount)/BEP (Sales revenue)/BESR = BEP (units) Selling price (SP) per unit = 1,200 Rs 3 = Rs 3,600
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-5

BEP (amount) = P/V ratio = BEP (amount)

Fixed costs Profit volume ratio (P/V ratio) Contribution margin per unit Selling price per unit = Rs 1,200 0.3333 = Rs 3,600

From the P/V ratio, the variable cost to volume ratio (V/V ratio) can be easily derived: V/V ratio = 1 P/V ratio In the vendors case, it is = 11/3 = 2/3 = 66.67 per cent The V/V ratio, as the name suggests, establishes the relationship between variable costs (VC) and sales volume in amount. The direct method of its computation is: Variable cost

Sales revenue

= Rs 2 Rs 3 = 66.67 per cent

Thus, P/V ratio + V/V ratio = 1 or 100 per cent (1/3 + 2/3) = 1 (33.33 per cent + 66.67 per cent) = 100 per cent
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-6

Margin of Safety Margin of safety is the excess of actual sales revenue over the break-even sales revenue.
The excess of the actual sales revenue (ASR) over the break-even sales revenue (BESR) is known as the margin of safety. Symbolically, margin of safety = (ASR BESR) When the margin of safety (amount) is divided by the actual sales (amount), the margin of safety ratio (M/S ratio) is obtained. Symbolically, M/S ratio = (ASR BESR)/ASR Assume in the vendors case that sales is 2,000 units (Rs 6,000); margin of safety (Rs 6,000 Rs 3,600) = Rs 2,400; and the M/S ratio is Rs 2,400 Rs 6,000 = 40 per cent. The amount of profit can be directly determined with reference to the margin of safety and P/V ratio. Symbolically, Profit = [Margin of safety (amount)] P/V ratio Or Profit = [Margin of safety (units) CM per unit] In the vendors case, profit = Rs 2,400 0.3333 (33.33 per cent) = Rs 800 or 800 Re 1 = Rs 800. The reason is that once the total amount of fixed costs has been recovered, profits will increase by the difference of sales revenue and variable costs.
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-7

1( b) Equation technique

The equation technique is particularly useful in situations where unit price and unit variable costs are not clearly defined. The excess of actual sales over the BE sales is the margin of safety. When margin of safety is divided by the actual sales, we get margin of safety ratio which indicates the percentage by which actual sales may decline without causing any loss to the firm

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-8

Sales revenue-Total costs = Net profit Breaking up total costs into fixed and variable, Sales revenue Fixed costs Variable costs= Net profit. Or Sales revenue = Fixed costs + Variable costs + Net profit. If S be the number of units required for break-even and sales revenue (SP) and variable costs (VC) are on per unit basis, the above equation can be written as follows:

SP (S) = FC + VC (S) + NI
Where SP = Selling price per unit S= Number of units required to be sold to break-even FC= Total fixed costs

VC= Variable costs per unit

NI= Net income (zero) SP (S)= FC + VC (S) + zero SP (S) VC (S)= FC
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-9

Example 2 SV Ltd, a multi-product company, furnishes you the following data relating to the current year: Particulars Sales Total costs First half of the year Rs 45,000 40,000 Second half of the year Rs 50,000 43,000

Assuming that there is no change in prices and variable costs and that the fixed expenses are incurred equally in the two half-year periods, calculate for the year:
(i)The profit-volume ratio, (ii) Fixed expenses, (iii) Break-even sales, and (iv) Percentage margin of safety. Solution Sales revenue Total costs = Net profit Rs 45,000 Rs 40,000 = Rs 5,000 (first half) Rs 50,000 Rs 43,000 = Rs 7,000 (second half) On a differential basis: Sales revenue, Rs 5,000 Total costs, Rs 3,000 = Total profit, Rs 2,000.
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-10

We know that only VC changes with a change in sales volume and, hence, change in total costs are equivalent to VC (Rs 3,000). Accordingly, the additional sales of Rs 5,000 has earned a contribution margin of Rs 2,000 [Rs 5,000 (S) Rs 3,000 (VC)]. P/V ratio V/V ratio = Rs 2,000 Rs 5,000 = 40 per cent. = 100 per cent 40 per cent = 60 per cent.

Accordingly, 60 per cent of the total costs are made up of variable costs and the balance represents the total fixed costs (FC). Sales revenue = Fixed costs + Variable costs + Net profit Rs 95,000 = FC + 0.60 (Rs 95,000) + Rs 12,000 Rs 95,000 = FC + Rs 57,000 + Rs 12,000 Rs 95,000 Rs 69,000 = FC or Rs 26,000 = FC BEP (amount) = Rs 26,000 0.40 = Rs 65,000

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-11

Verification Particulars Break-even sales Variable costs Contribution Fixed costs Net income Amount Rs 65,000 39,000 26,000 26,000 Nil Per cent 100 60 40 40 Nil

M/S ratio =

(Rs 95,000 Rs 65,000

Rs 95,000

= 31.58%

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-12

Break-Even Application
Sales Volume Required to Produce Desired Operating Profit

(Fixed expenses + Desired operating profit) P/V ratio

In Example 2, if the desired operating profit of SV Ltd is Rs 14,000, required sales volume = (Rs 26,000 + Rs 14,000)/0.40 = Rs 1,00,000 Operating Profit at a Given Level of Sales Volume [Actual Sales Revenue (ASR) Break-even Sales Revenue (BESR)] P/V ratio Effect on Operating Profit of a Given Increase in Sales Volume [Budgeted Sales Revenue (BSR) BESR] P/V ratio Suppose that SV Ltd forecasts 10 per cent increase in sales next year, the projected profit will be: (Rs 1,04,500 Rs 65,000) 0.40 = Rs 15,800

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-13

Additional Sales Volume Required to Offset a Reduction in Selling Price Suppose that SV Ltd reduces its selling price from Rs 10 a unit to Rs 9. The sales volume needed to offset reduced selling price/maintain a present operating profit of Rs 12,000 would be:
Desired profit (P) + Fixed expenses (FC) = Rs (12,000 + Rs 26,000) 0.3333 = Rs 1,14,000 Revised P/V ratio (Rs 3/Rs 9)

The required sales volume of Rs 1,14,000 represents an increase of about 20 per cent over the present level. The management should explore new avenues of sales potential to maintain the existing amount of profit
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Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

Effect of Changes in Fixed Costs A firm may be confronted with the situation of increasing fixed costs. An increase in the total budgeted fixed costs of a firm may be necessitated either by external factors, such as, an increase in property taxes, insurance rates, factory rent, and so on, or by a managerial decision of an increase in salaries of executives. More important than this in the latter category are expansion of the present plant capacity so as to cope with additional demand. The increase in the requirements of fixed costs would imply the computation of the following: (a) Relative break-even points. (b) Required sales volume to earn the present profits.

(c) Required sales volume to earn the same rate of profit on the proposed expansion programme as on the existing ones.
The effect of the increased FCs will be to raise the BEP of the firm. Assume the management of SV Ltd decides a major expansion programme of its existing production capacity. It is estimated that it will result in extra fixed costs of Rs 8,000 on advertisement to boost sales volume and another Rs 16,000 on account of new plant facility.
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-15

(a) The relative BEPs will be:

Present facilities = Fixed costs P/V ratio = Rs 26,000/0.40 = Rs 65,000.

Proposed facilities = (Present FCs + Additional FCs) P/V ratio. = (Rs 26,000 + Rs 24,000)/0.40 = Rs 125,000. It may be noted that increase in FCs (from Rs 26,000 to Rs 50,000) has caused disproportionate increase in the BEP (from Rs 65,000 to Rs 1,25,000). (b) The required sales volume to earn the present profit [Present FCs + Additional FCs + Present profit (NI)] P/V ratio.

= [Rs 26,000 + Rs 24,000 + Rs 12,000] 0.40 = Rs 1,55,000.

(c) The required sales volume to earn the present rate of profit on investment: (Present FCs + Additional FCs + Present return on investment + Return on new investment) P/V ratio.
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-16

Let us assume that the present investment is Rs 1,00,000 and the new investment will involve an additional financial outlay of Rs 60,000. The required sales volume will be (Rs 26,000 + Rs 24,000 + Rs 12,000+ Rs 7,200 (0.12 Rs 60,000)/0.40 = Rs 1,73,000. These computations may be reported in a summary form to the management as follows (Table 1). Table 1: Effect of Changes in Fixed Costs Particulars Present Prospective Increase facilities facilities Fixed costs Rs 26,000 Rs 50,000 Rs 24,000 BEP sales volume 65,000 1,25,000 60,000 BEP sales volume (units) 6,500 12,500 6,000 Sales volume to earn existing 95,000 1,55,000 60,000 profit Sales volume in units to earn 9,500 15,500 6,000 existing profit Sales volume to earn existing ROI 95,000 1,73,000 78,000 Sales volume to earn existing ROI 9,500 17,300 7,800 (in units)
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Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

Effect of Changes in Variable Costs

Assuming an increase of VC by Re 1 a unit for SV Ltd, the new contribution margin will be: Rs 3 (Rs 10 Rs 7) and the revised P/V ratio 0.30 that is, (Rs 3 Rs 10).
Revised BEP = (Rs 26,000)/0.30 = Rs 86,667 Desired sales volume to earn existing profit = Rs 38,000/0.30 = Rs 1,26,667 Assuming that variable costs of SV Ltd decline by Re 1 per unit, revised BEP = Rs 26,000/0.50 = Rs 52,000. Desired sales volume to maintain existing profit = Rs 38,000/0.50 = Rs 76,000. Effects of Multiple Changes So far we have assumed that a change takes place in one of the three variable affecting profitscost, price and sales volume. In cases where more than one factor is affected, the BEP analysis can be applied as shown below: FC + FC (new) + Desired NI 1 tax rate

[Contribution margin per unit (New SP New VC) New selling price (New SP)]
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-18

Assuming the following set of new Figures for SV Ltd: Particulars Selling price per unit Fixed costs Existing data Rs 10 26,000 New data Rs 11 40,000

Variable cost per unit

Contribution margin per unit Desired net income after taxes (to maintain the existing ROI) Tax rate Solution

6
4 12,000 35 per cent

5.50
5.50 25,000

Desired sales volume (on the basis of new data) [Rs 26,000 + Rs 14,000 + (Rs 25,0000.65)] 0.50, that is (Rs 5.5 Rs 11) = (Rs 78,461.5) 0.50 = Rs 1,56,923 Desired sales volume on the basis of existing data = [Rs 26,000 + (Rs 12,000 0.65)] 0.40 (Rs 4 Rs 10) = Rs 44,462 0.40 = Rs 1,11,154.

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-19

Multi-product Firms (Sales-mix) Example 3 The Garware Paints Ltd presents to you the following income statement in a condensed form for the first quarter ending March 31: Particulars Sales Variable costs Contribution Fixed costs Net income P/V ratio Break-even sales Sales-mix (per cent) Product X Rs 1,00,000 80,000 20,000 Y Rs 60,000 42,000 18,000 Z Rs 40,000 Rs 2,00,000 24,000 1,46,000 16,000 54,000 27,000 27,000 0.40 0.27 1,00,000 0.20 100 Total

0.20 0.50

0.30 0.30

If Rs 40,000 of the sales shown for Product X could be shifted equally to products Y and Z, the profit and the BEP would change as shown in Table 2.

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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Table 2 Break-even Point

Particulars
Sales Less: Variable costs Contribution Less: Fixed costs Net income P/V ratio BE sales Sales-mix (per cent)

Product
X Y Z Rs 60,000 Rs 80,000 48,000 56,000 12,000 24,000

Total
Rs 60,000 Rs 2,00,000 36,000 1,40,000 24,000 60,000 27,000 33,000 0.40 0.30 90,000 0.30 100

0.20
0.30

0.30
0.40

Example 3 shows that by increasing the mix of high P/V products (Y from 30 to 40 per cent, Z from 20 to 30 per cent) and decreasing the mix of a low P/V product (X from 50 to 30 per cent), the company can increase its overall profitability. In fact, it can further augment its total profits, if it can make, and the market can absorb, more quantities of Y and Z, say Rs 1 lakh each (Table 3).

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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Table 3 Particulars Sales Less: Variable costs Contribution Less: Fixed costs Net income P/V ratio BE sales Sales-mix (per cent) Product Y Rs 1,00,000 70,000 30,000 Z Rs 1,00,000 60,000 40,000 Rs 2,00,000 1,30,000 70,000 27,000 43,000 0.35 77,143 100 Total

0.30

0.40

0.50

0.50

From the above, it can be generalised that, other things being equal, management should stress products with higher contribution margins. For individual product line income statements, fixed costs should not be allocated or apportioned.

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-22

2(a) Break-Even Chart

The break-even chart is a graphic presentation of the relationship between costs, profits, and sales. It shows not only the break-even sales but also the estimated costs and profit at various levels of the sales revenue. It is, therefore, also referred to as volume-cost-profit (VCP) graph/chart Assumptions Regarding the VCP Graph are
1. Costs can be bifurcated into variable and fixed components. 2. Fixed costs will remain constant during the relevant volume range of graph. 3. Variable cost per unit will remain constant during the relevant volume range of graph. 4. Selling price per unit will remain constant irrespective of the quantity sold within the relevant range of the graph. 5. In the case of multi-product companies, in addition to the above four assumptions, it is assumed that the sales-mix remains constant. 6. Finally, production and sales volumes are equal.

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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Example 4
Selling price per unit Fixed costs Variable costs per unit Relevant range (units) : Lower limit : Upper limit Break-up of variable costs per unit: Direct material Direct labour Direct expenses Selling expenses Actual sales, 18,000 units (Rs 1,80,000) Plant capacity, 20,000 units (Rs 2,00,000) Tax rate, 50 per cent Rs 10 60,000 5 6,000 20,000 Rs 2 1.50 1 0.50

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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Y 200 Revenue and costs (in 000 rupees) 180 160

Relevant range

Variable cost area 140 120 100 80 60 40 20 0

0 4 6 8 12 16 18 20 24 Sales volume (in thousand units) Rs 120 Rs 180 Rs 240 Sales revenue (in thousand units) 40% 60% 80% Per cent of plant capacity 28 30 Rs 300 100%

BEP Margin of safety (units) Fixed cost line

Fixed cost line X

Or Rs 60 20%

Figure 1: Volume-Cost-Profit Graph (Traditional) Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-25

Figure 1 has been drawn by using a sales line and a total cost line (including both fixed and variable costs). The steps involved in drawing the VCP graph are enumerated as follows: 1. Select an appropriate scale for sales volume on the horizontal axis, say, 2,000 units (Rs 20,000) per square, and plot the point for total sales revenues at relevant volume: 6,000 units Rs 10 = Rs 60,000. Draw the sales line from the origin to Rs 2,00,000 (the upper limit of the relevant range). Ensure that all the points, 0, Rs 60,000 and Rs 2,00,000 fall in the same line. This should be ensured for the total cost line also. 2. Select an appropriate scale for costs and sales revenues on the vertical axis, say, Rs 10,000 per square. Draw the line showing Rs 60,000 fixed cost parallel to the horizontal axis. 3. Determine the variable portion of costs at two volumes of scales (beginning and ending): 6,000 units Rs 5 = Rs 30,000; 20,000 units Rs 5 = Rs 1,00,000. 4. Variable costs are to be added to fixed costs (Rs 30,000 + Rs 60,000 = Rs 90,000). Plot the point at 6,000 units sales volume and Rs 1,00,000 + Rs 60,000 = Rs 1,60,000. Point is to be plotted at 20,000 units sales volume. This obviously is the total cost line.

5. The point of intersection of the total cost line and sales line is the BEP. To the right of BEP, there is a profit area and to the left of it, there is a loss area.
6. Verification: FC CM per unit = Rs 60,000 Rs 5 per unit = 12,000 units or Rs 1,20,000
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-26

Figure 1 has been drawn using different scales for the horizontal and vertical axis. Figure 2 has been drawn on a uniform scale for both axes. Since the scales are the same, the 45 line will always be the proxy of the sales line. Any amount of sales revenue on the horizontal axis will correspond to costs and revenue on the vertical axis. Let us illustrate taking two sales levels.

1. Rs 60,000: FC = Rs 60,000 VC = 30,000 (50 per cent variable cost to volume ratio) TC = 90,000 Loss = 30,000 (TC, Rs 90,000 Rs 30,000, sales revenue) Thus, Rs 60,000 = Rs 60,000 + Rs 30,000 Rs 30,000. Point A in Figure 2 clearly shows these three relevant figures at the sales volume of Rs 60,000.
2. Rs 1,80,000: FC = Rs 60,000 VC = 90,000 TC = 1,50,000 Profit = 30,000 Thus, Rs 1,80,000 = Rs 60,000 (FC) + Rs 90,000 (VC) + Rs 30,000 (Profit). Point B in Figure 2 portrays these three relevant figures at the sales volume of Rs 1,80,000.
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-27

Y 240

Revenue and costs (in 000 rupees)

200

160 120 BEP

80

Fixed cost line

40

0 40 0 60 80 120 140 160 180 200 240

Sales revenue (in 000 rupees)

Figure 2: Volume-Cost-Profit Graph, Same Scale

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-28

The VCP graph in Figure 3 is drawn with the details of the individual segment of variable cost and is more informative. The steps involved in drawing the graph include an additional step of adding variable costs to the fixed cost. This is to be repeated four times for four different components: material, labour, direct expenses and selling expenses. In fact, fixed costs can also be further split-up into parts. Such a graph provides a birds-eye view of the entire cost structure to the management. By drawing a line perpendicular from any volume (horizontal axis), the corresponding cost and profit variables can be ascertained on the vertical axis. For instance, at 20,000 unit level, following are the various cost figures, as shown by the VCP graph (line A). Fixed costs Variable costs: Material Labour Direct expenses Selling expenses Profit before taxes
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

Rs 60,000 40,000 30,000 20,000 10,000 40,000

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Y 200
Rs 20,000 Net income Income tax
Selling expenses

Revenue and costs (in 000 rupees)

160 BEP 120

Rs 20,000
Rs 10,000

Variable costs & expenses

Rs 20,000

Direct expenses Direct labour cost

Total costs and expenses

Rs 30,000

80

Rs 40,000

Direct material cost

40

Rs 60,000

Fixed expenses (Factory, administration, selling)

12

16

20

Sales Volume (in thousand units)

Figure 3: Volume-Cost-Profit Graph, Cost-Wise

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

16-30

The VCP graph can be modified to show the changes in the profitability factors of Example 4, such as, 1.Change in fixed costs (Rs 10,000 both ways) 2.Change in variable costs (20 per cent both ways) 3.Change in selling price (25 per cent both ways). Table 4 provides a summary of the results due to the above changes. Only one change is taken at a point of time.

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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Table 4 Variable Fixed costs (Rs 10,000): Increase Decrease (Figure 4) Variable costs: Increase (to 60 per cent) Decrease (to 40 per cent) (Figure 5) Selling price (25 per cent): Increase Decrease (Figure 6) Effect on BEP Increase (Rs 20,000) Decrease (Rs 20,000) Margin of safety Decrease (Rs 20,000) Increase (Rs 20,000) Operating profit Decrease (Rs 10,000) Increase (Rs 10,000)

Increase (Rs 30,000) Decrease (Rs 20,000)

Decrease (Rs 30,000) Increase (Rs 20,000)

Decrease (Rs 18,000) Increase (Rs 18,000)

Decrease (Rs 20,000) Increase (Rs 60,000)

Increase (Rs 20,000) Increase (Rs 60,000)

Increase (Rs 18,000) Decrease (Rs 30,000)

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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320 280 Revenue and costs (in 000 rupees) 200 240 160 120 80 40

Profit (FC Rs 50)

BEP (FC Rs 70)
BEP (FC Rs 50) Margin of safety (MS)

Profits (FC Rs 70)

FC line (A) FC line (B)

450
0 0

40

80

120

160

200

240

280 320

Sales revenue (in 000 rupees)

Figure 4: Volume-Cost-Profit Graph, Change in Fixed Cost

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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Revenue and costs (in 000 rupees)

300 260 220 180 150 140 100 60 20

0 0

Profits Rs 48,000 (VC 40%)

BEP (VC 60%)
BEP (VC 40%)
Margin of safety (MS)

(MS)

Profits Rs 12,000 (VC 60%) FC line

450 X

40

80

120

160

200

240

280 320

Sales revenue (in 000 rupees)

Figure 5: Volume-Cost-Profit Graph, Change in Variable Cost

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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320

Revenue and costs (in 000 rupees)

320 320 200 160 120

Margin of

BEP (at lower SP) Profit (at higher SP)

Profit (at higher SP)

80 40
450
0 0

safety

FC line

40

80

120

160 200

240

280

320

Sales revenue (in 000 rupees)

Figure 6:Volume-Cost-Profit Graph, Change in Selling Price

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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Important Points Regarding Figure 6

In Figures 4 and 5, there are two cost lines to show the increase and decrease. But Figure 6, which is designed to reveal the change due to the selling price, has only one sales line (45). The impact of change in the sales price is reflected indirectly in the variable cost line (which is merged with FC line and is represented by the total cost line). This is due to the fact that the V/V ratio which is an essential input for drawing the chart gets changed when the selling price is changed. In other words, Figure 6 is like Figure 5. The new V/V ratio has been determined as follows. (1) When there is an increase in selling price by 25 per cent Sales price ( revised) = Rs 5.50 (Rs 10 + 25 per cent) or 125 per cent (Rs 12.5 per unit). Variable costs = Rs 5 or 50 per cent (existing).

V/V Ratio = (Rs 5 Rs 12.50) or (50 125) or 40 per cent.

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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(2) When there is a decrease in sales price by 25 per cent Sales price= Rs 7.50 (Rs 10 Rs 2.50) or 75 per cent (Rs 7.5 per unit). Variable costs= Rs 5 or 50 pr cent (existing). V/V Ratio= (Rs 5 Rs 7.50) or (50 75) or 66.67 per cent . Total cost line= Rs 60,000 + 66.67 per cent sales. Since the V/V ratio assumes a fractional form, care has been taken to plot points at sales levels of Rs 1,50,000 and Rs 2,40,000 so that corresponding variable cost figures can be whole numbers, that is, Rs 1,00,000 and Rs 1,60,000 respectively. Figure 7 portrays VCP relationships of a sales-mix for multi-product firm (Example 3).

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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160 Revenue and costs (in 000 rupees) 140 120

BEP (changed mix)

Total cost line (original mix)

BEP (original)

100 80 60 40 20
0 0

FC line

20

40

60

80

90

100

120

140

160

Sales revenue (in 000 rupees)

Figure 7: Volume-Cost-Profit Graph, Change in Sales Mix

Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

450

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Cash Break-Even Point The VCP relationship can also be used to show the liquidity position of the firm. This is done through the computation of cash break-even point or cash break-even sales revenue (CBEP/CBESR). Algebraically:

CBEP =

Total cash fixed cost (CFC) Contribution margin per unit Total cash fixed cost

Equation 1

CBESR =

P/V ratio

Equation 2

Graphically, the CBEP is determined at the point of intersection of total cash cost line and total sales line. The area to the left of the curve signifies cash losses and the area on the right side is indicative of cash profits. Assuming for Example 4, the cash fixed cost to be Rs 15,000, the CBESR using Equation 2 would be Rs 30,000 = Rs 15,000 0.50 Figure 8 portrays the graphic presentation of the cash break-even sales revenue.
Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala

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60 Costs and profit (in 000 rupees)

50 40 30 20 Total cash fixed cost 10 0 10 20 30 40 50 Sales revenue (in 000 rupees) 60

X

Cash BEP

Figure 8: Cash Break-even Point

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Dr. Shailendra Kumar, LMTSOM, Thapar University, Patiala