Chapter 16

Cost-Volume-Profit Analysis
Prescribed Textbook: Jawahar Lal, Seema Srivastav, Manisha Singh

CLO 2: To understand the link between cost and changes in volumes and
profitability and use this in decision making.
 Essentials of CVP Analysis

• Managers want to know how profits will change as the units

sold of a product or service changes.
• Managers like to use “what-if ” analysis to examine the
possible outcomes of different decisions so they can make the
best one.
• Relationship among the elements (selling price, variable costs,
fixed costs)
 Contribution
• Contribution means profit. According to Costing terminology,
contribution means not only profit but also fixed cost. It is defined as
the amount recovered towards fixed cost and profit.
• Contribution can be computed by subtracting variable cost from sales
or by adding fixed costs and profit. Contribution is helpful in
determination of profitability of the products.
• The following are the three products with selling price and cost details. Which
product is more profitable?
Product C is
more
Profitable

Product having more contribution is more profitable, as long as, there are no limitations on any factor of production
 Basic CVP Equations
To make good decisions using CVP analysis, we must understand these relationships.

Contribution Margin = Total Revenue - Total Variable Costs

OR
Contribution Margin = Contribution Margin per unit * Number of units sold

Contribution Margin per unit = Selling price per unit – Variable cost per unit
OR
Contribution Margin per unit = Contribution Margin/ Number of units sold

Operating Income = Contribution margin - Fixed costs

Contribution Margin Ratio (or Percentage) = Contribution Margin / Revenue

 CVP - Equation method and Contribution Margin method

• The equation method and the contribution margin method are most useful when
managers want to determine operating income at a few specific sales levels
• Equation Method
Revenues - Variable costs - Fixed costs = Operating income
(SP*Q) – (VC*Q) – FC = O/P Income
• Contribution Margin Method
Revenues - Variable costs - Fixed costs = Operating income
(SP – VC)*Q – FC = O/P Income
(Contribution Margin per unit *Q )– FC = O/P Income
 Cost-Volume-Profit – You Try It!

REVENUE – VARIABLE COSTS – FIXED COSTS = OPERATING INCOME

Example:

Tiny’s Cabinets sells cabinets for INR 600 each

Variable cost is INR 350 each

Annual fixed costs are INR 20,000

If Tiny sells 100 cabinets, what it his operating income?

 Cost-Volume-Profit – You Try It!
REVENUE – VARIABLE COSTS – FIXED COSTS = OPERATING INCOME

Tiny’s Cabinets sells cabinets for INR 600 each, Variable cost is INR 350 each, Annual fixed
costs are INR 20,000. If Tiny sells 100 cabinets, what it his operating income?
Equation Method [(SP X Q) - (VC X Q)] - FC = O/P Income
(INR 600*100) - (INR 350*100) - INR 20,000 = INR 5,000

Contribution Margin Method [(Contribution Margin per unit *Q )– FC] = O/P Income
Contribution Margin per unit = INR 600 - INR 350 = INR 250
INR 250*100 - INR 20,000 = Operating Income
 Profit Volume Ratio or Contribution Ratio
• P/V ratio = (Contribution /Sales )*100 or Contribution = Sales x P/V
ratio or Sales = Contribution / (P/V Ratio)

• Sales = Cost + Profit

• P/V ratio is 40%, then variable cost ratio is 60%, given variable cost ratio
is 70%, then P/V ratio is 30%. - Complementary relationship.

P/V ratio and variable cost ratios are said to be complements of each
other.
 Breakeven Point (BEP)

The breakeven point (BEP) is that quantity of output sold at which total revenue
equals total cost - that is, the quantity of output sold results in INR 0.00 of
operating income.
Recall our equation:
[(SP x Q) - VC x Q)] - FC = O/P Income
[(SP – VC) x Q] - FC = O/P Income
[CM x Q] - FC = O/P Income -------------- contribution margin method
@ BEP – O/P income is zero
CM per unit * Breakeven units = Fixed costs
Breakeven units = Fixed costs/CM per unit
 Breakeven Point-Example
Let’s try this for Tiny’s Cabinets. Recall that his SP = INR 600, VC = INR 350 and Fixed
Costs are INR 20,000, annually.

[(SP x Q) - (VC x Q)] - FC = OI --- Equation Method

(INR 600 x Q) - (INR 350 x Q) - INR 20,000 = 0
INR 250 x Q = 20,000

Q = 80----- Q is the Breakeven Quantity Units

Here’s another way to find the answer:
Breakeven revenues = FC / CM% Where CM% = CM/Revenue
Breakeven units = FC / CM per unit
 Breakeven Point-Example

Let’s try this for Tiny’s Cabinets. Recall that his SP = INR 600, VC = INR 350 and
Fixed Costs are INR 20,000
Here’s another way to find the answer:
Breakeven revenues = FC / CM %
Tiny’s CM per unit = INR 600 - INR 350 = INR 250
Tiny’s CM % = INR 250/INR 600 = 41.67%
INR 20,000 / INR 250 = 80
Or, in revenues INR 20,000/41.67% = INR 47,996 which is equal to 80 x INR 600,
allowing for rounding
 Break-even Formula
Breakeven revenues = FC / CM% Where CM% = CM/Revenue

Breakeven sales (units) = Fixed Cost / CM per unit

Breakeven sales (volume or revenues) = Fixed Cost / P/V ratio

Breakeven sales (volume) = Fixed Cost /(1- [total VC/total sales volume])

Cash Breakeven point (units) = Cash Fixed Cost / Cash CM per unit
 Break-even

• Selling price per unit = INR 20, Variable cost per unit = INR 10, Total fixed cost =
INR 1,00,000
 Cash Break-even
Chart
• BEP = (FC-Depreciation)/ (P-V)
• The cash break-even point is
lower than the usual break-even
point.
• Let sales 20,000 units at INR 10 per
unit, Variable costs, INR 4 per unit,
Fixed cost INR 50,000 including
depreciation, INR 10,000,
Preference divided to be paid INR
20,000, Taxed to be paid INR
25,000. Assume that there are no
lags in payment.
 Breakeven Point

A relationship is established among the cost, volume and profit, it is also

called Cost Volume-Profit Analysis (CVP analysis).
Note: Cost-volume-profit analysis, break even analysis and profit graphs
are interchangeable words.
Case 1 : Increase in No. of Units
Case 2: Changes in Sales
Case 3: Changes in variable cost
Case 4: Changes in fixed cost
Case 1: Increase in No. of Units
Case 2: Changes in Selling Prices
• A company produces a product with a selling price of INR10 per unit and a variable
cost of INR 4 per unit. Fixed costs are INR 36,000 per year. The effect of a 20%
increase and 20% decrease in the present selling price
Case 2: Increase in Sales due to increase in selling price.
Case 3: Changes in Variable costs
• A company is selling a product for INR 40 a unit and has a variable cost of INR 20
per unit. Fixed costs total INR 48,000 per year. The effects of a 20% increase and a
20% decrease in variable cost
Case 3: Decrease in variable cost
Case 4: Changes in fixed cost
• Assume that a company has a P/V ratio of 40% and present fixed costs of INR
50,000. The effects of change in the fixed costs by INR 10,000

BEP = Change in fixed costs / P/V ratio

Case 4: Changes in fixed cost
 Margin of Safety-Defined
• Margin of safety the difference between sales and the break-even
point.
• Margin of safety = Profit ÷ P/V ratio or
• Margin of safety = Profit * Sales/(Sales - Variable cost)

In other words, how far can they

fall before the company will
begin to lose money.
 Basic Assumptions in Break-even Analysis
• Selling prices and pricing policy will remain constant at all sales levels.
• All costs and expenses can be separated into fixed and variable components.
• The total of the fixed costs is constant at all sales levels; the unit variable costs remain
the same.
• Production and sales quantities are equal.
• Managerial policies, technological methods, and efficiency of men and machines
will not change and cost control will neither be strengthened nor weakened.
• Volume is assumed to be the only important factor affecting cost behaviour. Other
influencing factors such as unit prices, sales-mix, labour strikes, and production
methodology remain constant.
• In case of multiple products being manufactured by the enterprise, the sales-mix
should remain unchanged.
Curvilinear Break-even analysis

Optimum profit is earned

where the difference
between the sales and the
total costs is the largest
 Desired or Target Profit

What are the different avenues available for marketers to increase

their profits?
 Desired or Target Profit

Company A hopes to increase its profits by selling more units;

and to sell more, it plans to reduce its prices by 10%. The fixed
cost is 100,000

BEP when SP is 50 = BEP when SP is 45 =

Sales volume in physical units must be increased by 25%& Sales revenue is 12.5% .
 Desired or Target Profit

• Selling price increases by 20%.

 Product Mix

Which product is more profitable? How does sales volume have an impact
on profitability?
 Product Mix

• if the total sales volume is INR 1,00,000 equally divided between the two
products

Breakeven sales (Revenues) = Fixed Cost / P/V ratio = 25000/40%

= INR 62,500
 Product Mix

• If the sales mix is changed so that product A has 60% of the sales
revenue, the profit on sales of INR 1,00,000 would increase to INR
19,000.

Breakeven sales (Revenues) = Fixed Cost / P/V ratio = 25000/44%

= INR 56,818
 Sales Mix and BEP
• Assume, for a company, the fixed costs are INR 6,75,000. Further, assume that the
unit sales volume, units selling prices, unit variable costs, unit contribution margins
for products A, B and C are as follows:
Sales Mix and BEP Units
 Sales Mix and BEP Revenues

• Total P/V ratio = Total contribution/Total sales = 9,00,000/20,00,000 = 45%

• Break-even sales (INR) = Fixed cost/ Total P / V ratio = 6,75,000/ 45%
= INR 15,00,000
 Sales Mix and BEP

• Assume that the quantities sold of products A, B and C are 5,000 units,
20,000 units and 15,000 units, respectively. No changes w.r.t fixed costs,
variable cost per unit and selling price per unit.
 Sales Mix and BEP Revenues

• Total P/V ratio = Total contribution/Total sales = 7,00,000/20,00,000 = 35%

• Break-even sales (INR) = Fixed cost/ Total P / V ratio = 6,75,000/ 35%
= INR 19,28,571
 Sales Mix and BEP Units

BEP (units) = Fixed cost/ Weight contribution margin =6,75,000/17.50

= 38,571 units
Comparison – Sales Mix

Sales Mix (A-50%, B & C Sales Mix (A-12.5%, B-

– 25%) 50% & C – 37.5%)
Breakeven (units) 30,000 38,571
P/V Ratio 45% 35%
Breakeven Revenue 15,00,000 19,28,571
Profits (PBT) 2,25,000 25,000
Problem
Margin of safety INR 64,000, Break-even sales 1,600 units, Total cost INR
41,600, Margin of safety 6,400 units. Calculate the Fixed costs.
Solution:
Margin of safety (%) = Margin of safety (units)/ Actual sales (units) =
Total sales = Margin of safety(INR)/Margin safety (%) =
Profit = Total sales – Total cost =
P/V ratio = Profit/ Margin of safety (INR) =
Break-even sales = Total sales * (100 – Margin of safety %) =
Fixed costs = BEP * P/V ratio =
Problem
A company produces single product which sells for INR 20 per unit.
Variable cost is INR 15 per unit and fixed overhead for the year is INR
6,30,000. (a) Calculate sales value needed to earn a profit of 10% on sales.
(b) Calculate sales price per unit to bring BEP down to 1,20,000 units. (c)
Calculate margin of safety sales if profit is INR 60,000.
Solution
 Desired Profit and Tax

• Desired sales units = (Fixed Cost + PBT)/ Contribution margin per unit

• Desired sales units = (Fixed Cost + PBT)/ P/V ratio

• Sales unit for desired profit per unit = Fixed cost/ (Contribution margin
per unit - Desired profit per unit)

• Sales volume for desired profit (as percentage of sales) = Fixed cost/ (P/V
ratio - Profit margin)
Problem
WSM Enterprises introduced the Wizkid in 2019 to compete with Action Man.
Although the peak demand for these products occurred several years ago, sales
have stabilized and WSM sells 15,000 Wizkids a year. The recommended retail
price is INR 24.99 and the current wholesale price is INR 10.00. However, the
managing director wishes to increase the return on this product and has
proposed a 100% mark-up on total variable costs. WSM has an annual output of
15,000 Wizkids. The fixed costs related to this product are INR 40,000 and the
variable (or marginal) costs are INR 6.00 per unit.
(i) What is the breakeven volume of this product if a selling price of INR 10.00
is charged? What is the profit at this price? (ii) What price would the MD like to
charge? What would the resulting net profit be if there was no change in
demand? (iii) The marketing director has forecast a 10% drop in orders if the
price is raised as suggested. What would WSM’s profit be if this were to
happen? (iv) Discuss the other factors the MD should take into account when
deciding on the selling price of Wizkids.
Solution
(i)Contribution = 10 -6 = 4
• BEP units = 10,000 units
(ii) SP = VC + 100% mark up = 6+ 6 = 12
Net profit = T Contribution – FC = (15,000*6) – 40,000 = 50,000
(iii) (15,000 – 10%) Unit contribution = 13500*6 = 81000
Net profit = T Contribution – FC = 81,000 – 40,000 = 41,000
(iv) competitors’ prices; corporate objectives; pricing strategy; product life
cycle stage; and effect on profit of lowering prices and increasing demand.