COST-VOLUME-PROFIT ANALYSIS

COST-VOLUME-PROFIT ANALYSIS (CVP analysis) examines the behavior of total revenues, total costs, and
operating income as changes occur in the output level, selling price, variable cost per unit, or fixed costs of a
product.

USES OF CVP ANALYSIS

1. CVP analysis is used to determine how changes in selling prices, costs, and/or volume affect
2.

a company’s operating income and net income.

1. It can be used in preparing flexible budgets showing costs at different levels of production.
2.
3. It can be used to help in evaluating a start-up operation.
4.
5. It can be used to evaluate performance for the purpose of benchmarking and control.
6.
7. It can be used in setting pricing policies by projecting the effect of different price structures on cost and profit.
8.

ASSUMPTIONS OF COST-VOLUME-PROFIT ANALYSIS

1. Changes in the level of revenues and costs arise only because of changes in the number of product (or
service) units produced and sold.
2.
3. Total costs can be separated into a fixed component that does not vary with the output level and a
component that is variable with respect to the output level.
4.
5. When represented graphically, the behavior of total revenues and total costs are linear (represented as a
straight line) in relation to output level within a relevant range and time period.
6.
7. The selling price, variable cost per unit, and fixed costs are known and constant.
8.
9. The analysis either covers a single product or assumes that the sales mix, when multiple products are
sold, will remain constant as the level of total units sold changes.
10.
 11. All revenues and costs can be added and compared without taking into account the time value of money.
12.

LIMITATIONS OF COST-VOLUME-PROFIT ANALYSIS

1. Because of the many assumptions, CVP is only an approximation at best. CVP analysis needs estimates and
approximation in assembling necessary data and thus lacks accuracy and precision.
2.
3. In CVP analysis, it is assumed that total sales and total costs are linear and can be represented by straight
lines. In some cases, this assumption may not be found true. For instance, if a business firm sells more units,
the variable costs per unit may decrease due to more operating efficiencies in the factory.
4.
5. CVP analysis is performed within a relevant range of operating activity and it is assumed that productivity and
efficiency of operations will remain constant. This assumption may not be valid.
6.
7. CVP analysis assumes that costs can be accurately divided into fixed and variable categories. Such
categorization is sometimes difficult in practice.
8.
9. CVP analysis assumes no change in the inventory quantities, during the period. That is, opening inventory
units equal the closing inventory units. This also means that units produced during the period are equal to
units sold. When changes take place in inventory level, CVP analysis becomes more complex.
10.
11. If prices, unit costs, sales-mix, operating efficiency, or other relevant factors change, then the overall CVP
analysis and relationships also must be modified. Because of these assumptions, cost data are of limited
significance.
12.

REAK-EVEN SALES – that point of activity level (sales volume) where total revenues equal total costs, i.e., there
is neither profit nor loss.

Methods of Computing Break-even Point

a. Equation Method or algebraic approach

b.
c. Contribution margin method or formula approach
d.
e. Graphic approach
f.
GRAPHS OF CVP RELATIONSHIPS

The cost-volume-profit graph depicts the relationships among cost, volume, and profits.

Pesos
 Units Sold

The point where the total revenue line and the total cost line intersect is the break-even point.

MULTIPLE-PRODUCT ANALYSIS

When CVP analysis is used for a multiple-product firm, the product is defined as a package of products. For
example, if the sales mix is 3:1 for Products A and B, the package would consist of 3 units of Product A and 1
unit of Product B.

Break-even in packages for a multiple-product firm is then calculated as:

Break-even packages = Fixed Costs/Weighted average contribution margin

SALES MIX - the composition of total sales in terms of various products, i.e., the percentage of each product
included in total sales.

CVP ANALYSIS AND RISK AND UNCERTAINTY:

MARGIN OF SAFETY – indicates the amount by which actual or planned sales may be reduced without incurring a
loss. It is the difference between actual or planned sales volume and break-even sales.

OPERATING LEVERAGE – a measure of the extent to which fixed costs are being used in an organization. The
greater the fixed costs in relation to variable cost, the greater is the operating leverage available and the greater is
the sensitivity of income to changes in sales.

DEGREE OF OPERATING LEVERAGE (DOL) - a measure of the sensitivity of profit changes to changes in sales
volume. DOL measures the percentage of change in profit that results from a percentage of change in sales.

Degree of Operating Leverage (DOL) or Operating Leverage Factor (OLF) – a measure, at a given level of sales, of how a percentage
change in sales volume will affect profits.
 DEGREE OF OPERATING LEVERAGE (DOL)

OR =

Contribution Margin / Operating income

OPERATING LEVERAGE FACTOR (OLF)

The higher the degree of operating leverage, the greater the change in profit when sales change.

PERCENTAGE CHANGE IN PROFIT = DOL × Percentage change in sales

SENSITIVITY ANALYSIS - a “what if” technique that examines the impact of changes on an answer. For example,
computer spreadsheets are used to analyze changes in prices, variable costs, and fixed costs on expected profits.

Factors Affecting Profit

1. Selling price per unit4. Fixed cost

2.
3. Variable cost per unit5. Sales mix
4.
5. Volume or number of units
6.

Exercises:
 1. A company’s projected profit for the coming year is as follows:
2.

Sales (@ ₱20) ₱200,000 Less: Variable costs (@ ₱12) 120,000 Contribution margin₱ 80,000

Less: Fixed costs 64,000

Operating income₱ 16,000

Required

a. Calculate the contribution margin per unit and the break-even point in number of units.
b.
c. Calculate the contribution margin ratio and the break-even point in pesos.
d.
e. How many units must the company sell to earn operating income equal to ₱30,000 before tax?
f.
g. How much revenue must the company generate to earn operating income equal to ₱20,000
h.
i. If the company desires to earn pre-tax profit of 20% of sales, how much should sales be?
j.
k. If the company desires to earn an after-tax profit of 11.25% of sales. The income tax rate is 25%. How
much should sales be?
l.
m. How many units must be sold to earn a desired pre-tax profit of ₱3 per unit?
n.
o. How many units must be sold to earn an after-tax profit of ₱3 per unit?
p.
q. Refer to the original data. If the cost of labor would decrease from ₱3 to ₱1 per unit, what effect would this
have on the units that must be sold to earn the same profit of ₱16,000? What effect would this have on
the break-even point?
r.
1. MARGIN OF SAFETY AND OPERATING LEVERAGE
2.

Kids’ Haven produces and sells miniature toy pianos. The variable costs to produce the toy pianos, on the average,
are ₱2,000 per unit, and fixed manufacturing costs are ₱18,000 per month. Kids’ sells the toy pianos at an average
price of ₱3,200 each.
The selling and administrative costs that the company incurs in a typical month are presented below:

COSTSCOST FORMULA

Selling:

Advertising₱700 per month

Sales salaries and commissions₱950 per month, plus ₱150 per unit sold Delivery expenses₱30 per unit sold

Utilities₱350 per month

Depreciation of sales facilities₱800 per month

Administrative:

Executive salaries₱2,500 per month

Insurance₱400 per month

Clerical₱1,000 per month, plus ₱20 per unit sold

 Depreciation of office equipment ₱300 per month

During May, the company sold and delivered 40 units of toy pianos. REQUIRED:

a. Prepare an income statement for Kids’ Haven for the month of May. Use the traditional
b.

format, with costs organized by function.

a. Redo (1) above, this time using the contribution margin format, with costs organized by behavior. Show
costs and revenues on both a total and a per unit basis down through contribution margin.
b.
c. Compute the breakeven point in units, in pesos, and in percentage form.
d.
e. Compute the margin of safety in units, in pesos, and in percentage form.
f.
g. Compute the degree of operating leverage. If sales revenues are expected to increase by 20 percent, what
is the percentage increase in profits?
h.

1. SENSITIVITY ANALYSIS.
2.

The income statement for Fellows, Inc., is as follows:

Sales₱650,000

Less: Variable expenses 240,000

Contribution margin₱410,000
 Less: Fixed expenses 295,200

Operating income₱114,800

Fellows produces and sells a single product. The income statement is based on sale of 100,000 units.

Required:

a. Compute the break-even point in units and in revenues.

b.
c. Suppose that the selling price increases by 10 percent. Will the break-even point increase or decrease?
Recompute it.
d.
e. Ignoring the price increase in Requirement 2, suppose that the variable cost per unit
f.

increases by ₱0.35. Will the break-even point increase or decrease? Recompute it.

a. Can you predict whether the break-even point increases or decreases if both the selling price and the unit
variable cost increase? Recompute the break-even point incorporating both of the changes in
Requirements 2 and 3.
b.
c. Assume that total fixed costs increase by ₱50,000. (Assume no other changes from the original data.) Will
the break-even point increase or decrease? Recompute it.
d.
1. Indifference Point.
2.

A company has decided to introduce a new product. The new product can be manufactured by either an automated
method or a manual method. The manufacturing method will not affect the quality of the product. The estimated
manufacturing costs by the two methods are as follows:
AutomatedManual

Variable manufacturing costs ₱ 72 ₱ 112

Variable selling and administrative costs 8 8

Fixed manufacturing costs ₱ 480,000 ₱ 220,000

Fixed selling and administrative costs 80,000 80,000

The company’s market research department has recommended an introductory unit sales price

of ₱ 240.

Required:
 Determine the annual unit sales volume at which the company would be indifferent between the two
manufacturing methods.

1. SENSITIVITY ANALYSIS
2.

The Zapatos Company produces its famous shoe, the Walker, that sells for P3,000 per pair. Operating income for
this year is as follows:

Sales revenueP6,000,000

Variable cost (P1,200 per pair) 2,400,000

Contribution marginP3,600,000

Fixed cost 2,000,000

Operating incomeP1,600,000

Zapatos Company would like to increase its profitability over the next year by at least 25%. To do so, the company
is considering the following options:

a. Replace a portion of its variable labor with an automated machining process. This would result in a 20%
decrease in variable cost per unit, but a 10% increase in fixed costs. Sales would remain the same.
b.
c. Spend P300,000 on a new advertising campaign, which would increase sales by 20
 d.
e. Increase both selling price by P500 per unit and variable costs by P200 per unit by using a higher quality
leather material in the production of its shoes. The higher priced shoe would cause demand to drop by
approximately 10%.
f.
g. Add a second manufacturing facility which would double Zapatos’ fixed costs, but would increase sales by
50%.
h.

Required:

Evaluate each of the alternatives considered by Zapatos. Do any of the options meet or exceed Zapatos’ targeted
increase in income of 25%?

6.Sales MIx

Male Accessories, Inc. sells wallets and money clips. Historically, the firm’s sales have averaged three wallets for
every money clip. Each wallet has an ₱8 contribution margin, and each money clip has a ₱6 contribution margin. The
company incurs fixed cost in the amount of ₱180,000. The selling prices of wallets and money clips, respectively, are
₱32 and ₱15. The corporate-wide tax rate is 40 percent.

Required:

1. How much revenue is needed to break even? How many wallets and money clips does this represent?
2.
3. How much revenue is needed to earn a pre-tax profit of ₱150,000?
4.
5. How much revenue is needed to earn an after-tax profit of ₱150,000?
6.
7. If the company earns the revenue determined in (b) but does so by selling five wallets for every two money
clips, what would be the pre-tax profit (or loss)? Why is this amount not
8.

₱150,000?
 1. The following data pertains to Zoomi Trading. At a selling price per unit of ₱15, variable cost per unit of ₱9,
fixed cost of ₱400,000, and an unknown volume of units “U”, Zoomi Trading makes a profit equal to “P”.
2.

Furthermore, if the variable cost per unit goes down to ₱6, the fixed cost goes up by 25%, and both the selling price
per unit and unknown volume of units “U” are held constant, Zoomi Trading doubles its profit to “2P”.

Required:

Solve for the unknown volume of units “U” and the profit “P”.

1. Hampshire Trading has the following information: Selling price per unit of ₱15, variable cost per unit of ₱8, and
total fixed cost of ₱500,000.
2.

What volume will allow it to earn a profit equal to 20% of the contribution margin?

1. Light One Corp. sells two (2) types of specialized flashlights. Premium Ray sells for ₱500 per unit, and Beta
Ray sells for ₱300 per unit. They share a common process and differ only in the materials used. The annual
fixed cost is estimated to be ₱5,000,000. The variable cost per unit for Premium Ray is ₱300, and ₱180 for Beta
Ray. At a certain annual volume “V”, Light One Corp. makes a profit of ₱400,000. At that volume “V”, the mix
is 75% Premium Ray and 25% Beta Ray.
2.

Compute for the volume “V”.

Total Revenue ProfitTotal CostBreak-Even Point Loss