Cost-Volume - Profit Analysis

Cost-volume –Profit Analysis
 CVP analysis is the the tool to study how

cost & profits change with changes in
production volume.
 Volume refers to the quantity or units
produced.
 CVP considers only two cost categories :
1. Fixed cost
2. Variable cost
Application of CVP analysis
1. Planning sales budget
2. Profit planning
3. Acceptance & rejection of special orders
4. Make or buy decisions
5. Determination of capacities & selection
of equipments
6. Continue or shut down
Basic CVP Model
 The main question to be answered is how
much the organisation needs to sell (either
in units or in Rs.) to break-even i.e. no
profit no loss situation.
 To answer this question one uses break-
even analysis.Typically accountant uses
linear break-even analysis for short term
situations within a limited range to
calculate:
1. Single Product Breakeven
2. Multi-product breakeven
3. Units for target profit
4. Expected profit.
Construction of a break-even chart
 It involves drawing of fixed cost line,total cost
line & sales line as follows:
1. Select X axis as output units & Y axis as total
costs & sales(Rs.).
2. Draw a fixed cost line which is horizontal line
parallel to the X axis.
3. Draw total cost line (by joining total costs at
different levels of output) starting from the
horizontal line(F.C.).
4. Draw sales line starting from zero & joining sales
points at different levels of output.
Linear Break even chart
Break even
Point
Costs &
Revenues
Fixed Cost
Volume
Basic formula for CVP model.
Single product BEP
 At break-even point :
Total revenue = Total Costs
= Fixed cost + Variable costs
S.P.* Q = F.C. + V.C.* Q
Q at B.E.= F.C./ (S.P – V.C.)
= F.C./( Contribution per unit)
Break-even analysis
Basic Concepts-Break even sales
 Contribution = S.P. – Variable cost
 Profit/Volume (P/V) ratio(%):
(Contribution/sales)*100
 Break even sales (Quantity):
Fixed Cost/Contribution p.u.
 Break even sales (Value):
Fixed cost/(P/v ratio)
Break-even analysis
 Margin of safety = Actual sales – Break even sales
 Margin of safety ratio =
Actual sales – Break even sales * 100

Actual sales
= Profit at selected activity

P/V ratio
Sales required for budgeted profit :
1. In quantity : Fixed cost + Budgeted Profit

Contribution p.u.
2. In Value : Fixed cost + Budgeted Profit

P / V ratio
CVP-Multiple Products
Calculation of overall BEP
 Calculate total contribution by adding contributions of individual
products.
 Divide it by total number of units (for all the products sold) to get
average contribution for the sales mix.
 Overall BEP in units = Total Fixed cost
Avg. Contribution
 BEP (units) for individual products will be then calculated
proportionately for number of units of individual products in the sales
mix.
 BEP in value can be calculated by adding sales value of individual BEP
units or can also be directly calculated as:
Overall BEP(Rs.) = Fixed cost
O. P/V ratio
Where Overall P/V ratio = Total contribution
Total sales
Methods of determining Cost
Behaviour
1.High & Low points method
2.Scattergraph method
3.Accounting or analytical approach
4.Least Squares regression method
5.Multiple regression method
High Low point method
 The highest & lowest levels of volume are
chosen for the period under review.
 Variable cost per unit is determined by
dividing the difference in total cost by
difference in number of units.
 Fixed cost is then calculated by deducting
total variable cost from the total cost.
Scattergraph Method
 In this method various costs are plotted on the
Y-axis & various activity levels are plotted along
the X-axis.
 A straight line is fitted to this scatter of points by
visual approximation.
 The slope of the line is the estimated variable
cost whereas the intercept of the line with Y-axis
denotes fixed cost.
 The estimated fixed cost is deducted from the
total cost at a particular level to get the total &
per unit variable cost.
Scattergraph
Qtr. Units Costs Scattergraph

1st 1700 275 400
300
2nd 1600 265
200
3rd 1950 290 100
4th 2400 340 .5 1 1.5 2 2.5
Simple Regression Analysis
 It is a tool to examine relationship between two
variables;one independent & one dependent.
 This tool is used for forecasting future sales/costs by
using the trend line based on the relationship.
 The trend line is given by the least square equation:
Y= mx + c
Where : Y= dependent variable
x= independent variable
m=degree of variability
c = fixed element
Multiple Regression analysis
 This is used in case of more than 2
variables I.e. one independent & 2 or
more dependent variables .
 It is given by the equation:
y = m1x1+m2x2+m3x3+…….+c
Due to presence of number of
variables,the accuracy of prediction of Y is
improved compared to the simple
regression analysis.
Accounting or Analytical Method
 This involves close scrutiny & classification

of costs by accountant using his
judgement ,knowledge & experience.
 It is a very simple & inexpensive approach
 However it lacks accuracy as they involve
mere guesses.
Limitations Of Break-even analysis
 It does not depict a complete picture e.g.it fails to

determine ROI & denotes only profit to sales ratio.
 Number of assumptions (indicated below)are made in
Break-even analysis due to which the BEP is only an
approximation:
1. All costs can be clearly segregated into fixed &

variable elements.This may be complex making the
BEP inaccurate.
2. Cost & profit depend entirely on volumes which may
not be true e.g.inflation can change cost & revenue
which is not related to volumes
3. Costs & revenue patterns are linear over levels of
output being considered.
Limitations Of Break-even analysis
4. Fixed costs remain constant & variable costs vary in

proportion to the volume.
5. Constant sales mix or only single product is

manufactured.
6. Production & sales are the same I.e.changes in stock

levels are not significant.
7. Units of production are same to calculate overall

BEP.
8. At varied levels of output contribution margin per

unit is constant.
Curvilinear CVP Analysis
 This is an economists concept relating to CVP to be used in the long
range.
 It is based on the following concepts:

1. Marginal cost is the change in aggregate cost when volume changes
by one unit.
2. If selling price is reduced demand increases though not in direct

proportion.
3 With increase in volume of production the total costs increase ,first

at a declining rate then at a constant rate & then at an increasing
rate to give diminishing return due to operational inefficiencies.
4 Hence there can be more than two break-even points as shown in

the curvilinear break-even chart.
Curvilinear Break-even chart
Rs. Sales
BEP
cost
BEP
Units

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Cost-volume –Profit Analysis

 CVP analysis is the the tool to study how

 Margin of safety ratio =

Actual sales – Break even sales * 100

= Profit at selected activity

Sales required for budgeted profit :

1. In quantity : Fixed cost + Budgeted Profit

2. In Value : Fixed cost + Budgeted Profit

Qtr. Units Costs Scattergraph

 This involves close scrutiny & classification

 It does not depict a complete picture e.g.it fails to

1. All costs can be clearly segregated into fixed &

4. Fixed costs remain constant & variable costs vary in

5. Constant sales mix or only single product is

6. Production & sales are the same I.e.changes in stock

7. Units of production are same to calculate overall

8. At varied levels of output contribution margin per

 It is based on the following concepts:

2. If selling price is reduced demand increases though not in direct

3 With increase in volume of production the total costs increase ,first

4 Hence there can be more than two break-even points as shown in

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