Cost-Volume-Profit

5 Analysis
lotroduction; Meaning
CHAPTER OUTLINE
of CVP analysis; Breek-even analysis;
Assumptions;
Contribution and marginal cost equation; P/V ratio; Calculations in break
Pyen analysis; Margin of safety; Key factor; Angle of incidence;
Break-even
chart: Profit volume chart; Uses and limitations of Break-even
analysis:
Summary of formulae; Problems and solutions; Key terms; Examination
questions.

oduction
Tast-volume-profit aralysis (CVP analysis) is an extensicn of the principles of variable costing.
sour study of CVP analysis begins from where we left our study of variable costing in the
ious chapter. CVP analysis follows directly from variable costing. This means that
ived and applied in variable costing are applicable here.
principles
Eery company must eam profits to stay in business. CVP analysis helps management in profit
mning. Managers make various plans to increase company profitability. For example, how the
its will be affected if an additional sales promotional expenditure of 2,00,000
sby 40,000 units? Similarly, how many units of product should be sold to eam a increases
profit of
50,000? If company sells 1,50,000 units, what will be the amount of profit ? These and many
e similar questions find their answers in the study of CVP analysis.

CoST-VOLUME-PROFIT ANALYSIS

cby5
factors of is a powerful tool of profit planning. It studies the inter-relationship of three
business operations:
a) Cost of
)Volume product
of ion,
Profit. production/sales,
and

efactors are inter-connected in such a way that they act and react on one another
ng hrieeand effect relationship amongst them. The cost of a product determines its
and the selling price determines thelevel of profit. The selling price also affects the
Wnich directly affects the volume of production and volume of production in tum
5.1
5.2
variations in volume of production results in
Management r
inftuences cost. In brief,
CINA London has defined CVP
cost
analysis as, "the study of the effects on
sales price, quantity and
mix.
changes
future in cost ana
profits oh
tn fixed cost variable
An understanding of CVP analysis is extremely useful to managernent in budgeting a
following on the net profit :
planning. It explains the impact of the
(a) Changes in selling prices,
(b) Changes in

(d) Changes
Infact,
volume of sales,
() Changes in variable
cost,
in fixed cost.
CVP analysis
eledlarAC
helps in determining the probable effect of change in any one of t
factors on the remaining factors.
BREAK-EVEN ANALYSIS

widely used technique to study the CVP relationship. It is int

Break-even analysis is a
broad sense.
in narrw as well as break-even analysis is concerned with i t
Narrow meaning. In its narrow sense,
that level of production and sales where there is no profit and e
break-even point, i.e., equal to total sales revenue.
point total cost is
At this
in broad sense, break-even analysis is used to determine rola
Broad meaning. When used amgt
level of production/sales. It also helps to determine the
profit/loss at any given
amount of profit.
volume of sales to earn a desired Analysis
Analysis and CVP
Aaumptions underiying Break-even assumptions
the following eight
The break-even analysis is based on and variable components.
into fixed
1. All costs can be separated constant and total variable cost varies in direct propa
remains
2. Variable cost per unit
to the volume of production.
3. Total fixed cost remains constant.
Selling price per unit does not change as volume changes.
4.
the case of multiple products, the sates
or in the sale of various P
5. There is only one product several products are being sold,
change. In other words, when
will always be in some predetermined proportion. v
synchronisation between production and sales. In other words, volune
6.There is
equals volume of sales.
7. Productivity per worker does not change.
8. There will be no change in the general price level.
Contribution and Marginal Cost Equation (variabl
marginalcontribut
and the Thus
As stated earlier(contribution is the difference bet ween sales Imargin.
of sales. It is also known as contribution margin (Cm) or gross
calculated by the following formula :
Contribution - Sales Variable cost (C = S - )
 lshmePrfit
Anaysle

5.3

Also, Contribution = Fixed cost + Profit (C= F+P)

Contribution = Fixed cost- Loss (C- F-L)
Romthis,the following marqinal cost
S- VF+P
equation is developed :
the above four
threeof factors in the equation are
any
If Thus: known, the fourth one can be easily
ndout. P-S-V -F
P C-F
F C- P
V= S- F -P
mple:
Sales = R 12,000
Variable cost 7,000
Fixed cost 4,000
Thus
C= S- V
C= 12,000- 7,000 =5,000
P= C- F
P= 5,000- 4,000 = 1,000
Ehus profit is 1,000.
f sales fiqure is not given but
contribution is given then sales can be determined as follows:
S=C+V
S 5,000 + 7,000 = 12,000
hen fixed cost (F) is not given but profit is
given, then :
F= C - P
F =5,000 - 1,000 = 4,000
hen variable cost () is not given, then :
V= S - C
V= 12,000- 5,000 7,000
cOncept of contribution is extremely helpful in the study of break-even analysis and
agement decision-making.
stration 5.1
Calculate connttribution in each of the following independent situations :
) Fixed cost 8,000,
@) Vañable cost 7.000,profit 5,600
(i) sales R11,000
ution
)
Contribution per unit R 7, profitR 3,000, B.E. Point 2,000 units.

Contribution -Fixed cost + Profit

=8,000 + 5,600 R 13,600
 5.4

(i) Contribution
(i) Contribution
-Sales - Variable
-11,000- 7,000
cost
4,000
-(B.E. Point (units) x Contríbution
-(2,000 x 7) + 3,000 17,000
per unit) +Profit Monageh,
PROFIT-VOLUME RATIO (P/V RATIO)
contribution
profit/volume ratio, better known as /sales ratio (C/s
The
relation of
contribution to sales.

Symbolically, P/V ratio

Contribution C S-V Tatio),
Sales S

we have
By transposition, ratio
() C- S x P/V
C
() S- PIV ratio
Sales? 10,000
Example:
Variable cost = R 8,000
10,000-8,000 2,000
C S-V
Then PN ratio S 10,000 10,000 10

2
100= 20%.
in percentage, P/V ratio =
When expressed 10

When P/N ratio is given, the contributionP/V can be quickly calculated from anycan cibe r
above example, if only sales and ratio were given, contribution
sales. In the
as under :
C= Sx P/V ratio
C=10,000 * 20% =2,000
computed by comparing the change in contribution to change t
P/V ratio may als0 be
change in sales.) Any increase in profit will mean increase in co
(or change in profit to assumed to remain constant at all levels of production. Thus
because fixed costs are
Change in contribution Change in profit
P/V ratio = Change in sales = Change in sales

Example : Net Profit

Year Sales

1,000
2011 20,000 1,600
2012 22;000
1,600- 1,000
P/V ratio= Change in profit 22, 000- 20, 000
x 100
Change in sales
600
X100 = 30%.
2,000
dest-VolmeProfitAnalvsie 5.5

Mustration5.2
CalculateP/V ratio in each of the following independent situations.
60,
Contribution 40
Variablecost cost 15
20, variable
) Sales variable cost to sales 84%
Ratio of 25,000; Fixed Cost
Profit 5,000: Sales 8,000
(0) Sales 50,000, Total cost 40,000.
(v) Year I Sales 60,000, Total cost 45.000
Year II
Solution

ratio-
Contribution Contribution 40 40
100-40%
(0P/V Sales Variable cost + Contribution 60+40
20-15 5
'Contribution S-V
(ö) P/V ratio -
25%
Sales S 20 20
HY PN ratio- 100- Variable cost to sales ratio
- 100 - 84% 16%.

Contribution F+P 5,000 +8,000 13,000 13

(iv) P/V ratio - Sales 25,000 25,000 25

() P/V ratio Change in profit 15,000-10,000 5,000

10,000 50%
Change in sales 60,000- 50,000
"Profit is the difference between sales and total cost.
Jses of P/V ratio
N ratio is one of the most important ratios to watch in business. It is an indicator of the rate
t which profit is being earned. A high P/V ratio indicates high profitability and a low ratio
adicates lowW profitability in the business. The profitability of different sections of the business
ch as sales areas, classes of customers, product lines, methods of production, etc., may also
Compared with the help of profit-volume ratio. The P/V ratio is also used in making the
lowing type of calculations:
(a)Caleulation of break-even point.
b) Calculation of profit at a given
level of sales.
(0) Calculation of the volume of sales
(0 Calculation of profit when required to eam a given profit.
e) Calculat margin of safety is givern.
adon
is Teduced. of the volume of sales required to maintain the present level of profit, if selling price

mprovement in P/V Ratio

As P/V
ratio
a
fixed cost indi c ates the rate of profitability, any improvement in this ratio without increase
by merewould result in higher profits. As a.note of caution, erroneous conclusions may be
ratio is thereference
ap PNbetween to P/V ratio. Therefore, this ratio should not be used in isolation.
function of sales and variable cost. Thus, it can be improved by widening the
(0) sales and variable cost. This can be achieved by :
0) ncreasing the selling price
Peducing the variable cost
6.6

(c) Changing the sales mix, i.e., selling more of f

improving the overall P/V ratio.

METHODS
Break-even analysis may be performed
OF
those products which
BREAK-EVEN ANALYSIS
by the following two
haye
Man gemet
(a) Algebraic calculations methods:
(b) Graphic presentation
Algebraic Method (Calculations in Break-even Analysis)
Bfeak-even point. The break-even point is thevolume of
output or sales at
Kexactly equal to sales. It is a point of no profit and no loss
production at which total cost is recovered and after this point This is the which t
The fundament al formula to calculate break-even point is
profit minimum
begins.
Total fixed cost
Break-even point (in units)
Contribution per unit
Total fixed cost x Sales = Fxs
Break-evea point (în Rupees) Contribution S-V
Total fixed cost
or Break-even point (in Rupees) P/V ratio
Example
Following data is given :
Total fixed cost = 12,o00
Selling price ilat 12 per unit
Variable cost S 9per unit
Thus
Contribution
- 12 9
- 3 per unit
P/V ratio -x100 =x100 -25%
Fixed cos t 12,000 A000 units.
Break-even point (in units)= Contribution per unit 3

Total fxed cost * Sales

Break-even point (in ) Contribution
12,000
12 = 48,000
3
Also,
Total Fixed cost R12, 00DO - 48,000
Break-even point (in )
P/V ratio 25%
 5.7
wt#olmeProfit
Analysie

Wentication be verified as follows

point may
Break-even Fixed cost + Variable cost
Total cost
12,000 + (4,000 units x 9)
Total cost
-
-48,000

and total cost at break-even point are exactly equal.

value
salesCALCULATIONS
pTIONAL
The
above formula can also be used in
calculation of break-even point, the
to the
addition additional calculations. These are :
In
certain volumes.
making at different sales
Calculation of profit desired profit.
1.
of sales for
2. Calculation
missing figures.
3. Fnding
ample
is given:
The following data 7 12,000 (total)
Fixed cost
price =12 per unit
= 9 per unit
hle cost
Volumes
lalation of Profit at different Sales
What will be the profit when sales are (a) 60,000 (b) 1,00,000 ? a
3
P/V ratio = = 25%
12
(a) When sales -60,000
Contribution = Sales x P/V ratio
-60,000 x 25% = 15,000
Profit = Contribution - Fixed cost
-15,000- 12,000 = 3,000
(0) When sales - 1,00,000
Contribution
Profit
= 1,00,000 x 25% = 25,000
=R25,000- 12,000= 13,000.
lclation of Sales for Desired
Profits
Continuing the same figures, what will be the amount of sales if it is desired to earn aprofit
(a)R 6,000; (b)
Sales for desired15,000?
profit - Fixed cost + Desired profit
P/V ratio
12,000+6000
-72,000
25%
S12,000+15,000 -1,08,000.
25%
 5.8

Caleulation of Missing figures

Example t
Management he
Break-even point 30,000
Given:
Profit -R1,500
Fixed cost -6,000
cost ?
What is the amount of varable
Solution
Contribution Fixed cost + profit
6,000 + 1,500 7,500
Fixed cost
Break-even point Contribution * Sales
6,000
30,000 x Sales
Ve S-C 7,500
F31S00-7SOD 6,000
Sales x 30,000? 37,500
7,500
Contribution 7,500
P/V ratio = * 100
Sales 37.500* 100 209
Variable cost = 100 - P/V ratio
Variable cost = 100 - 20% = 80% (of sales)
Variable cost (80% of sales) 37,500 x 80% = 30,000
Variable cost at break-even sales = 30,000 x 80% =R 24.000
Also, variable cost at Break-even sales- 30,000- Fixed cost
Z 30,000 - 6,000 = 24,000.
Example :
Sales = 4,000 units @ 10 per unit
1,500 units
Break-even point
Fixed cost -3,000
?
What is the amount of (a) variable cost; and (b) profit
Solution
Fixed cost
Break-even point (in units) = Contribution per unit
73,000
1,500 = Contribution per unit

? 3,000
Contribution per unit = 1.500 units =2

(a) Variable cost = Selling price - Contribution

= 1 0 - 2 - 8 per unit
Contribution at sales of 4,000 units = 4000 units x 2- 8,000
(b) Profit Contribution - Fixed cost
-8,000- 3,000 5,000.
 5.9

Fxed
cost 8,000 C 100oD
Profitearned 2,000
Break-even sales 40,000
?
actual sales
otisthe

antibution
at break-even point is equal to fixed cost. low
8,000
P/V ratio =

Actual Sales
S 40,000
Fixed cost + Profit
P/V ratio
= 20%
|S-Sbaso
8,000 + 2, 000 10,000
20% - 50,000
20%

Selling price 150 per unit

Variable cost 90 per unit
Fixed cost 6,00,000 (total)
t is the break-even point?
at is the selling price per unit if break-even point is 12,000 units?

Fixed cost
Break-even point=
Contribution per unit
6,00,000 6,00,000
150-90 - 10,000 units.
60
hen break-even point is 12,000 units, contribution is calculated as under :
6,00, 000
12,000
Contribution
Contribution = 6,00,000
12,000 units = 50
C= S- V
50 S - 90
S= 50 + 90
S= 140
seüng price is 140 when
tatig 5.3 break-even point is 12,000 unuts.
folloSales
wing information is given
? 2,00,000
VarFixediablecostcost 1,20,000
30,000
 5.10

Calculate (a) Break-even

point
() New break-even point if selling price is reduced by 10%
Management tey
e New break-even point if variable cost increases by 10%
(d) New break-even point if fixed cost increases by 10%
Solution (B.Com. Madure
S-V 2, 00, 000- 1,20, 000 80,000
P/ ratio S 2,00, 000
2,00,000
(a) Break-even point -P/V ratio
30,000
75,000
40%
100-4%
() When selling price in reduced by 10%, new sales - 2.00,000- 10l%

New P/V zatio

1,80, 000-1,20,000 60,000 1 1,80,000
1,80, 000 1,80,000 3
30,000
New Break-even point -P/V ratio 1/3 90,000
(c) When variable cost încreases by 10%, new variable cost
- 1,20,000 + 10%- 1,32,000
2,00,000-1,32, 000 68,000
New P/V ratio 2,00,000
10034%
2,00, 000
30,000
New Break-even point 34%
-88,235 (Approx).
(If fixed cost increases by 10%, new fixed cost = 30,000 + 10% 33,000
P/V zatio remains unaffected at 40%
33,000
New Break-even point 82,50o.
40%

Tastration 5.4
From the following particulars, find out the selling price per unit if B.E. Point is to ba tou
down to 9,000 units
Variable cost per unit =? 75
Fixed expenses =? 2,70,000 (B.Com., Cal
Selling price per unit 100
Solution
Fixed cost
Break-even point =
Contribution per unit
9,000 units = 2,70,000
Contribution per unit

Contribution per unit 2,70, 000 -30.

9,000
 meProfit
Analysts
5.11

25 (i.e., 100- 75). n order to bring B.E. Point at 9,000 units,

contribution is
should
the be brought
present
to Z 30. This means that selling price should be increased by 5. Thus,
t
ntrution shouldbe 105.
nea
selling pricE
atratlon
he
S.5
the following data :
given { 4,000
be areexpenses
Rxed
Reak-even point 10,000

aiilate
PYratio 20,000
are
Profit when sales price is reduced by 20% (B.Com., Delhi)
break-even point if selling

btion
fixed cost thus when sales are? 10,000,
break-even point, contribution is equal to
R
ntribution4000,
4,000 x 100 = 40%
FX 100 =
10,000

hen sales are 20,000, contribution will be

20,000 x 40% = 8,000
Profit - Contribution - Fixed cost
=8,000 4,000 =R 4,000
New break-even point when selling price is reduced by 20%.
New sales figure - 20,000 - 20% =? 16,000
Variable cost 12,000
Contribution = 16,000 - 12,000 = 4,000
4,000
New P/V ratio 25%
16,000 =
F 4,000 =
New Break-even point 16,000.
P/V ratio 25%
Cah Brealk-even point
When break-even point is calculated only with those fixed costs which are payable in cash,
mt abreak-even point is known as cash break-even point, This means that depreciation and
e h-cash fixed costs are excluded from the fixed costs in computing cash break-even point.
formda is -
tash break even point Cash fixed costs
=
Contribution per unit
MARGIN OF SAFETY (M/S)
Matjn
vint :In of safety may be defined as tthe difference bet ween actual sales and sales at break- even
other Words, i1s of sales exceeds the break-even
the amount by which actual volume
 5.12

pomt. Nargn or Sarety may be expressed in absoluta. money terms or

as a Management Actoh
M/S- Actual sales - Break-even point percentage of s
Example :
Company X
Actual sales 1,20,000 Compay
Less : Break-even point 40,000 60,000
Margin of safety 80,000 40,000
80, 000 20,000
Margin of safety as a % of sales 1,20,00o * 100 20,000
60,000 x 100
2
- 66% -

The size of the margin of safety indicates soundness of a business. When margin afee
large, it means the business can still make proffts after a serious fall in sales. In such a y
the business stands better chance of survival in times of depression. Alarge marain f ,
usually indicates low fixed costs. When margin of safety is low, any loss of sales may be àm
of a serious concern.
Margin of safety is directly related to profit. This is shown below :
Profit = Margin of safety x Profit/volume ratio
P= M/S x P/V ratio
P
Thus M/S = P/V ratio
If profit is 10%% and P/V ratio is 40%, then0s2
10%
M/S = 25%
40%

When actual sales are given

Profit- M/S ratio x P/V ratio x Actual sales
When profit is not known but M/S is known, then
P= M/S x P/V ratio
P= 25% x 40%o = 10%

Also
Profit
M/S in units = Contribution per unit improveit
be taken to
When margin of safety is not satisfactory, the following steps may fixed cost,P
Reduce
(a) Increase the volume of sales, (b) Increase the selling price, (c)products with larger
Reduce variable cost, (e) Improve sales mix by inecreasing the sales of
ratio. paintnd
The effect of a price reduction is always to reduce P/V ratio, raise the break-even
shorten the margin of safety.
 5.13
meyf
Anayste
t

t lustratedbelow:

Variable cost 50 per unit. Actual sales 75,000. Suppose price is

buple
f y to 6O
Before After
príce reduction price reduction

75 60
perunit (S) 50 50
(n
n eprieper unit 10,000 10,000
aaNecost
cost() 25 10
Daxnd (S
Oetiution

60 6
10,000 10,000
Beak-even point 1/3 1/6
-30,000 -60,000
75,000 75,000
ktual sales 75,000 - 30,000 75,000 - 60,000
B.E. Point)
WS (Actual sales - - 45,000 - 15,000

ebe reducing price from 75 to 60, P/V ratio has reduced from 1/3 to 1/6, break even
Lbs apne up from 30,000 to 60,000 and M/s has come down from 45,000 to 15,000.
tyton 5.6
Sdate margin of safety in each of the following independent situations.
Break even point 40%, Actual sales ? 40,000
BActual sales - 40,000 units, Break-even point 25,000 units
m) Break-even point - 75%
PrV ratio 40%, Profit ? 35,000
1 Contribution per unit 20, Profit 15,000

) Margin of safety Actual sales BE Point

-40,000- 40% 24,000
Margin of safety Actual sales - BE point
9 Kargin of safety - 100
40,000 units 25,000 units
- BE Point 100 75%
15,000 units
- 25%
MMargin of Profit
safety P/V ratio
35000 -87,500
40%
9
Margin of safety Profit Rs. 15,000
- 750 units
P/V ratio Rs. 20
aDestatyofiton 5.1yvoune
qlied to ratio of Escorts Ltd. is 50% and the nargin of safety is 40%. You are
wOkont the net profit. and the break-even point if sales volume is 10,00,000.
 5.14

Solution Manangageemment
Sales
Less: Matgin of safety (40% of sales)

Contribution - Sales P/V ratio Break-even point 10,4,000,0,000000

Contribution at B.E. Point 6,00,000 x 50%3,00,000
At break-even point, the entire amount of
6,00,000
contribution is fixed cost
since
point.
Thas, ixed cost 3,00,000. there is O
Profit - Contribution - Fixed cost
Contribution on sales of 10,00,000 10,00,000 x 50%
5,00,000
Profit
5,00,000 3,00,000- 2,00,000
These caleulations can be verified as follows : SD
Profit M/S x P/V
-40% x 50% 20% of sales
Profit - 10,00,000 x 20%2,00,000.
IMlustration 5.8
Calculate break-even point in each of the following independent situations :
() Fixed cost 10,000; P/V ratio 50%
(ü) Fixed cost ? 15,000; Contribution 3 per unit.
(itt) Margin of safety- 20%
(iv) Pixed cost 9,000, Variable cost to sales ratio = 60%
() Actual sales 50,000, Margin of safety 30%
(i) Profit ? 30,000, Margin of safety 20%, Variable cost is 70% of sales.
(vi) Margin of safety ? 70,000, Actual sales 4,00,000.
(vitt) Actual sales 10,000 units, Margin of safety 2,500 units
Solution
Fixed cost ? 10,000
() BE Point R 20,000
P/V ratio 50%

() BE Point Fixed cost R15,000

-5,000 units
Contribution per unit ?3
(if) BE Point- 100 Margin of safety in %- 100 - 20- 80% of sales
() P/V satio 100- 60% 40%
Fixed cost 9,000
BE Point 22,500
P/V ratio 40%
(v) BE Point Actual sales- Margin of safety
-50,000- 30%35,000
JomPrefit
Analysie 5.15

70% 30%
100
PVatio- Profit 30,000
)
p/ Vratio - 30% 1,00,000
Wargin of satety
Margin of safety 1,00,000
Margin of safety% 20%
-5,00,000
Actualsales
Actual sales - Margin of safety
RE Point -5.00,000- 1,00,000 - 4,00,00o

Frtioation x P/V ratio

Actual sales x M/s tatio
5,00,000 x 20% 309y,
t 30.000-
Point Actual sales- Margin of safety
BE -4,00,000- 70,000 R3,30,000
Actual sales- Margin of safety
BE Point 7,500 units
- 10,000 units- 2,500 units
stration 5.9
independent situations :
Nate contribution in each of the following
25,000; P/V ratio 30%.
9 Margin of safety 15,000; Fixed cost
Also calculate profit in this case.
) BE Point 40,000; P/V ratio 40%; Profit 10,000.
) Nargin of safety 40%; Profit 30,000.
() P/V ratio 40%; Profit 50,000; BE Point 1,00,000.
VMargin of safety 4,000 units; contribution 3 per unit; Fixed cost 30,000.

0 Contribution - (M/s in ?x P/V ratio) + Fixed cost (1 Ms- Soooo

- (? 15,000 x 30%) + 25,000 - 29,500
Profit -M/S x P/V ratio 15,000 x 30% 4,500 MIs 24fales - BEr
or Profit -C-F = 29,500 - 25,000-4,500 A- Sale 25S0o
() Contribution - (BE Point x P/V ratio) + Profit
- (40,000 x 40%) + 10,000- 26,000
22SDoD yoY
() Contribution= Profit 30,000 =R 75,000
Margin of safety in% 40%
ontribution =(BE Point x P/V ratio) + Profht
Ay Contribution --(Margin
(? 1,00,000 * 40%)in + units50,000
of safety 90,000per unit) + Fixed cost
x Contribution
- (4000 units x 3) + 30,000= 42,000
lastration 5.10
Cacal)atFxed
e profit in each of the following independent cases
0) cost 37,000; Contribution 84,000.
Variable cost 80% sales, Margin safety
of of ratio 30%, Sales 1,00,000.
 5.16

Bxed cost 2,00,000; Margin of safety 50%, P/V ratie

(iv) Margin of safety 70,000, Variable cost ratio to
Vanany
(v) Actual sales 80,000; P/V ratio 20%, Fixed cost sales 35%
10.00n
Solution
() Contribution - Fixed cost + Profit
84,000 37,000 + Profit
Profit - 84,000- 37,00047,000
() P/V atio 100 80%- 20%
Profit - Sales x M/S ratio x P/V
ratiote
-1,00,000 x 30% x 20% 6,000
Fixed cost 2,00,000
(iii) BE Point -5,00,000
P/V ratio 40%

Margin of safety Margin of safety

Margin of safety ratio Actual sales BE Point + Margin of safety
Suppose Margin of safety - x
X
x% =
5,00,000 +X

50% = 5,00,000 +X

X= 0.50 (5,00,000 + x*)

- 2,50,000 + 0.5x
X - 0.5x = 2,50,000
X-5,00,000
Thus margin of safety - 5,00,000
Profit - Margin of safety x P/V ratio
- 5,00,000 x 40% = 2,00,000
c2 Verification
Actual sales = BE Point + Margin of safety
- 5,00,000 + 5,00,000 = 10,00,000
Profit Actual sales x M/S ratio xP/V ratio
- 10,00,000 x 50% x 40% 2,00,000
(iy) P/V ratio 100 -35% 65%
Profit -Marçin of safety x P/V ratio
70,0c0 65% = 45,500
(V) Profit -Contribution - Fixed cost
-(Actual sales x P/V ratio)- Fixed cost
-(80,000x 20%) - 10,000 - 6,000badt Lo
 b J m P y i tAnahvele 5.17

Jtastration5.11
ShortQuestions
60%, Fixed cost 2,10,000, Variable cost ratio to sales 70f%.
Nargin of safety sales.
0 the amount of actual
Determine
40,000, Fixed cost 15,000. What is the P/V ratio?
Point
0)BE 12,000, Actual sales 48,000, Margin of safety ? 8,000.
Fxed cost
)
What is the
P/V ratio ?
when P/V ratio 40%, Margin of safety 30%, Profit ? 12,000.
Fnd out the BE Point
() at 60% of capacity sales and P/V ratio is 30%. What is the
Break-even point occurs when
)
amount of capacity
sales fixed cost is 1,80,000. Also find the amount of profit
at 72% of
capacity sales.
? 50,000 contribution
of safety when profit is point.
7o.000
hat is the amount of margin
determine the break even
7,00,000. Also
and sales
Calculate the amount of actual sales when profit ? 20,000, break- even point 50,000
H)
and fixed cost 25,000.
is the amount off fxed
e) Variable cost is 80% f sales and margin of safety is 40%. What
2,00,000.
cost if sales are
Solution
() P/V ratio - 100 - 70% 30%

BE Point
Fixed cost
2,10,000 -1,00,000
P/Vratio 30%

BE Point in 7,00,000 7,00,000

Sales -17,50,000
100- M/ S% 100 - 60% 40%

Verification
BE Point -Actual sales- M/S
- 17,50,000- 60% =7,00,000
(iD) BE Point Fixed cost
P/V Ratio
. P/V ratio - Fixed cost 15,000
B.E Point 40,000 x 100 - 37.50%
(in) BE Point
Actual sales- Margin of safety
-48,000-8,000 40,000
P/N ratio Fixed cost 12,000
BE. Po int * 100 30%
(i) Profit 40,000
- Actual sales x Marqin of safety % * P/V ratio
.
Actual sales Profit 12,000 -1,00,000
BE Point M/S ratio x P/V atio 40% x 30%
- Actual Sales Margin of safety
1,00,000- 30% -70,000
5.18

() BE Point
Fixed cost
P/Vratio
1,80,000-6,00,000
30%
Management
6,00,000 10,00,000
Capacity sales 60%
10,00,000 x 72%7,20,000
capacity
Sales at 72% of P/V ratio) - Fixed
cost
Profit -(Sales x 1,80,000- 36,000
(7,20,000 30%) -
70,000 100- 10%
Contribution x 100
(v) P/V ratio Sales
7,00,000

Margin of safety
Profit
P/Vratio
50,0005,00,000
10%

- Profit
=Contribution so
Fixed cost 000 20,000nhats
-70,000
Fixed cost 20,000 -Z 2,00,000 out
BE Point P/Vratio 10%
000005
Fixed cost 25,000 = 50%
(vti) P/V ratio BE Point 50,000
25,000 + 20,000 =90,000
Fixed cost + Profit
Sales P/V ratio 50%

(vii) P/V ratio - 100 - 80% = 20%

40% = 1,20,000
Break even sales = 2,00,000-
Fixed cost
BE Point - P/Vratio
Fixed cost Break-even Point x P/V ratio
= 1,20,000 x 20% 24,000
FACTORS
LIMITING OR KEY
to earn maximum profit. However, it is, not always ey
The objective of a business is is affected by a variety of factors. For
example,
objective because profit earníng
this
sufficient orders on hand, ample skilled labour and production ofcapacy
maximunqs
may have manufacture and
unable to obtain all the quantity of material it needs for the the Size of outputableto
which could be sold. Thus, material is the factor which limits a business isnot
sometimes
an undertaking from maximising its profit. Similarly,
that it can produce. In such a case, sales is the limiting factor. activities ofanund
Ea
in the outout
Alimiting or keyfactor may thus be defined as the factor of valume
which at a particular point in time or over a period will limit the
limiting actors are
() Sales (i) Materials
machine hours
(in) Labour of particular skill (iv) Production capacity or
(v) Financial resources.
 eProfit
Analvsie
5.19

the limiting factor technique is to indicate the most profitable course of action
The
purposeof
where
alternatives are possible.
unit of key factor-When a key factor issoperating, the most profitable
ached
Contribution when
per contribution per unit of key factor is maximum. For instance, if a choice
producing product A which yields a contribution of 15 per unit and product B
eteen contibution of 20 per unit, product B would be more profitable.
yeldsa
A
takes 3kg., of material (which is a limiting factor) and product Btakes
biot productcontributions per kg. of material would be :
howeve
therespective
t 3 kg. = 5
A15 -?4
Poduct 20 + 5 kg.
PreductB - the greater contribution in terms of per unít of líniting factor will be
hich gives
A.
Aect
proitable.
Sestration512
given :
following data at is Product A Product B
The
Direct materials
24 14
hour 6 9
@ 3per
Direct labour hourg al tiaa 812
ariable overhead @4 per 100 110
Selling price 2 hrs. 3 hrs.
Standard time
manufacture when :
Sate which product you would recommend to
(a) Labour time is the key factor
(b) Sales value is the key factor.
Ssution
ProductA Product B

Selling price (S) 100 110

Ditect materíal 24 14
Ditect labour 6 9
lariable overhead 8 12
Variable cost (V) 38 35
Contribution (S- V) 62 75
9) Contribution per 75 3 hrs.
labour hour 62 + 2 hrs.
-31 25
V ontribution per
rupee of sales value - 6 2 + 100 - 7 5 + 110

-62 paise - 68 paise

anlu(a)sion
Product
labour
Ais
Tecommended when labour time is the key factor because contribution per
0) hour of product Ais more than that of product B.
When sales
Tupee of value is the key factor, product Bis recommended
() Vhen esales value of product Bis more than that of product A.
because contribution per

Per unitsale is quantity is the key factor, product Bis more profitable because its contribution
higher than that of product A.
 5.20
ANGLE OF INCIDENCEot Management Ae
and
by the intersection of sales line total cost line at the
formed

earning prbroeahtks-e.n
(see angle
This Fig. 5.1).
is This angle shows the rate at which profits are being earned once the bre
rate of
reached. The wider the angle, the greater is the
point has been will be to have as large an angle as possible.
the aim of
management
importance in boom periods when The
is of particular
The angle
Taking of incidencewith
in conjunction sales expan
margin of safety, therefore, a large angle of incidenceare with a
and extremely favourable position.
margin of safety indicates
COST INDIFFERENCE POINT
Cost indifference point refers to that level of output where the total cost or the profit ot
two alternatives are equal. Such a level may be calculated where two or more alternative met
of production or machines are considered and the use of one machine involves higher fixed
and lower variable cost per unit while the other machine involves lower fixed cost and tigh
variable cost per unit. The calculation of point of cost indifference helps iin a cost minimisa
exercise and identifies the alternative which is more profitable for a given level of outgt
alas A machine with a lower fixed cost and a higher variable cost per unie is more profit
whenactual sales are bèlow the point of cost indifference and vice versa, a máchine with ahig
unit is more prohtabte when actual sales are me
5ixed cost and a lower variable cost performula for calculation is as follows
the point of cost indifference. The Difference in fixed cost
Cost indiference point (in units) = Diference in contribution per unit
Difference in fixed cost at
Cost indifference point (in )= Diference in P/ Vratio
Illustration 5.13
Ltd. has to choose between machine X, and X, and provides the following data
GMR Co.
X
10,000 10,000
Output per annum (units) 24,000
Profit at the above level ? 30,000
Fixed cost per annum 30,000 16,000
Compute
(0) B.E. Point of the two machines.
() Level of output where the two machines are equally profitable
Ka The machine suitable for different levels of output of the product.
Sotution
Contribution Fixed cost + Profit.
MachineA 30,000 + 30,000 =60,000
Machine B= 16,000 + 24,000 = 40,000
Cor contribution per unit - A=60,000 10,000 units = 6
B- 40,000+ 10,000 units =4
Break-even point- C + C
A=30,000+ R6= 5,000 units
B= 16,000 + R 4 4,000 units
 - olmeProfitAnalysie

5.21
Cost indifference point = Difference in FC
( Difference in C
30,000-16,000
6-4
14,000
units. both the machines -7,000 units
2
At 7,000 will
produce the same amount of
(th)MachineBwill be more profitable between break-even point profit.
hetween 4,000 units and 7,000 units. and point of cost
Ais more profitable when sales one more than 7,000 units. indifference
GRAPHIC PRESENTATION OF BREAK-EVEN ANALYSIS
reak-even Chart

meak-even chart is a graphic presentation of

the point at which the total cost break-even analysis: This
line and the sales line chart takes its name from
ne fact that
eint. Abreak-even chart not only shows the point intersect is the break-even
break-even
but
rarious levels of activity. also shows profit and loss
280

260

240
les
line

220 Sale
lsin

200
000,
2 180 Angle of incidençe
Profit Area
u 160
YnuYat Break even point
40
Totalcostline
120
pue
100 Variable cost
1so
80
Loss Area
60

40
Margin of safety
20 Fixed cost
Break even sales Actual sales
2 4 6 8 10 12 14 16 820 22 24 26 28
Units of Production or Sales in '000
Fig. 5.1. Break-even Chart
() break-even chart portrays the following informat ion :
() TheBreak-even point the point at which neither profit nor loss is made.
(i) The profit/\oss at different levels of output.
relationship
between variable cost, fixed cost and total cost.
 5.22

(v) The
(iv) angle ofofincidence,
The margin
Manangemeem
safety. indicating the rate at which DIOfit is being made.

of contribution at various levels of sales. (This can be

(v) The amount'contribution break-even chart)
desiqned
Break-even Chart
Construction of
The principal steps in the construction of a break-even chart are as follows :
al
scale on X-axis. The X-axis is a horizont base line which
into a
Selectdistances
1. equal to represent any one or more of the following factors:1s drawn

(units)
() Volume of output (in rupee value)
(i)) Volume of output(units)
(üt) Volume of sales
(iv) Volume of sales (in rupee value)
percentage)
(v) Production capacity (in
The Y-axis is a
vertical line at the
extreme left of the
scale on Y-axis.
2. Select
distances. On this Y-axis, it is usual to show cost and cha
is spaced into equal
is drawn parallel to X-axis, starting from
salanesappropi
in TRe
3. Draw the fixed cost line. This 30,000, it will be plotted
when fixed cost is as is
shoWwn in
on Y-axis. For example,
Y-axis
100

90+

80

70
60
50
40+
cost
Fixed

20+
10 X-axis
80 90 100
10 20 30 40 50 60 70

Fig. 5.2. Break-even Chart Steps 1, 2 and 3 super-i

chart by
4. Drawthe total cost line. The variable cost is depicted from in the pointonthe
the (ixedco
on the fixed cost line. Thus a total cost line is drawn starting 50,000 th
represents fixed cost. For example, when total variable cost is point of Y-axis,to
30,000), a total cost line is drawn from 30,000, the fixed cost 5.3.
below in Fig.
CUst point on the right side of the Y-axis. This is shown
left (theinters
5. Draw the sales line. This line statts from the 0 point at the
ntolmeProfitAnalvsie

Yaxis 5.23
100

90

'o00)80
70
(R Totalcost
cost
Variable
sales 60
and 50
Cost
40
30
Fixed cost
20

10+

10 20 40 50 60 X-axis
70 80 90 100
Fig. 5.3. Break-even Chart Steps 4
m Y-axis, where there is no
thar sales value. Further production at a nil cost) and extends to the point of maximum
nn) the sales assuming sales R 1,00,000 (ixed cost
line will be drawn from 0
point at the left to the 30,000, variable cost
ais. This is illustrated in Fig. 5.4. 1,00,000 point on the
sales line intersects the total cost line at
break-even point representing 60,000 sales and
1 xis
S a l e
l i
s n e

90

80
aarea
Profit

70

60 Totalcostl i n e

50 Break
feven point
404
3 30Loss area

20
10

10 20 30 40 50 60 7o 80 90 X-axis
100
Fig. 5.4. Break-even Chart Steps 5