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Chapter 5

Cost-Volume-Profit (CVP) analysis evaluates the relationship between selling price, sales volume, expenses, and profit, aiding in pricing, product mix, and marketing strategies. Key factors influencing profits include selling price, sales volume, variable costs, fixed costs, and sales mix, while techniques like contribution margin analysis and break-even analysis are essential for understanding profitability. CVP analysis helps managers make informed decisions by assessing contribution margins, break-even points, and margins of safety.

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21 views4 pages

Chapter 5

Cost-Volume-Profit (CVP) analysis evaluates the relationship between selling price, sales volume, expenses, and profit, aiding in pricing, product mix, and marketing strategies. Key factors influencing profits include selling price, sales volume, variable costs, fixed costs, and sales mix, while techniques like contribution margin analysis and break-even analysis are essential for understanding profitability. CVP analysis helps managers make informed decisions by assessing contribution margins, break-even points, and margins of safety.

Uploaded by

hanose
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Introduction to Cost-Volume-Profit (CVP) Analysis

 Definition: CVP analysis examines the relationship between selling price, total sales
revenue, production volume, expenses, and profit.
 Uses:
o Setting selling prices
o Selecting the product mix
o Choosing marketing strategies
o Analyzing the impact of cost changes on profitability

Factors Affecting the Level of Profits


Key factors that influence profit levels:

1. Selling Price
2. Volume of Sales
3. Variable Cost per Unit
4. Total Fixed Cost
5. Sales Mix (the proportion of different products sold)

Techniques of CVP Analysis


1. Contribution Margin Analysis
2. Break-Even Analysis
3. Profit-Volume Analysis

Fixed Costs

 Definition: Costs that do not change with activity levels (e.g., rent).
 Behavior:
o Total fixed costs remain unchanged regardless of production volume.
o Fixed cost per unit decreases as activity increases.

Variable Costs

 Definition: Costs that change proportionally with activity (e.g., raw materials).
 Behavior:
o Total variable costs increase as production increases.
o Variable cost per unit remains constant.
Mixed Costs

 Contain both fixed and variable components (e.g., utility bills).


 Example: Monthly electricity charge includes a fixed service fee and a variable cost
based on usage.

1. Contribution Margin Concept


 Definition: The amount by which sales revenue exceeds variable costs. It represents the
profit potential of a business.
 Formula:
Contribution Margin = Sales − Variable Costs

Contribution Margin Ratio

 Formula:
Contribution Margin Ratio = (Contribution Margin ÷ Sales) × 100%
 Use: Helps assess the impact of sales volume changes on profit.

Example:

Given:

 Sales = $100,000
 Variable Costs = $60,000
 Fixed Costs = $30,000

Contribution Margin = $100,000 − $60,000 = $40,000


Profit = Contribution Margin − Fixed Costs = $40,000 − $30,000 = $10,000

Contribution Margin Ratio = 40%

2. Break-Even Analysis
 Definition: The sales level at which a business neither earns a profit nor incurs a loss.
 Break-Even Point (Units):
Break-Even Units = Fixed Costs ÷ Contribution Margin per Unit
 Break-Even Point (Dollars):
Break-Even Sales = Fixed Costs ÷ Contribution Margin Ratio

Example:
 Fixed Costs = $30,000
 Contribution Margin per Unit = $20

Break-Even Units = $30,000 ÷ $20 = 1,500 units

3. Target Operating Income


 Formula (Units):
Target Sales Units = (Fixed Costs + Target Income) ÷ Contribution Margin per Unit
 Formula (Dollars):
Target Sales Dollars = (Fixed Costs + Target Income) ÷ Contribution Margin Ratio

4. Margin of Safety
 Definition: The difference between actual or budgeted sales and break-even sales. It
indicates how much sales can drop before the business incurs a loss.
 Formula:
Margin of Safety = Actual Sales − Break-Even Sales

Example:

 Actual Sales = $100,000


 Break-Even Sales = $87,500

Margin of Safety = $100,000 − $87,500 = $12,500

5. CVP Analysis for Multiple Products


 Sales Mix: The ratio of different products sold by a company.
 Products often have different selling prices, variable costs, and contribution margins.

Example of Sales Mix:

A company sells Model X, Y, and Z with a ratio of 2:3:5.

 Model X: Sales Price = $50, Variable Cost = $30, Contribution Margin = $20
 Model Y: Sales Price = $25, Variable Cost = $15, Contribution Margin = $10
 Model Z: Sales Price = $10, Variable Cost = $8, Contribution Margin = $2
Total Contribution Margin for 10-unit basket = (2 × $20) + (3 × $10) + (5 × $2) = $80

Break-Even Point for Multi-Product Sales

Break-Even Units = Fixed Costs ÷ Contribution Margin per Basket

6. Preparing a CVP Graph


 Total Revenue Line: Starts at the origin, with a slope equal to the unit sales price.
 Total Fixed Cost Line: Horizontal line from the vertical axis.
 Total Cost Line: Slope equals the variable cost per unit.
 Break-Even Point: The intersection of the total cost and total revenue lines.

Conclusion
Cost-Volume-Profit analysis is a powerful tool for making decisions about pricing, product mix,
and cost control. By understanding the contribution margin, break-even point, and margin of
safety, managers can make informed decisions that drive profitability.

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