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## Cost Volume Profit Analysis

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**Cost Volume Profit Analysis**By Ghanendra Fago For MBA, AIM**Cost-Volume-Profit Analysis**• Study of relationship between costs, volume, and profits. • If 10% volume changed, what is the expected change in profit and cost? • If 10% cost changed, • If volume and cost changed, what is the expected change in profit? • Break even analysis – A techniques of CVP analysis By Ghanendra Fago (M. Phil, MBA) For AIM**Use of CVP Analysis**• What level of sales is needed to avoid the losses? • What sales volume is needed to earn a target profit? • What would be the effect on profits if we reduce our selling price and sell more units? • What sales volume is required to meet the additional fixed charges arising from an advertising campaign? • What will be the effect on the profit, where sales mix is changed? • What will be the new-break-even point when there is change in prices, costs, volume, and sales mix? • Which product or product mix is most profitable? • Which product or product mix should be discontinued or not? By Ghanendra Fago (M. Phil, MBA) For AIM**Assumptions of CVP Analysis i.e Certainty Analysis**• Costs can be divided into fixed and variable elements • Fixed costs will remain constant • Variable cost per unit and selling price remain constant. • A company produces a single product. If multiple product mix remains constant. • Production equals to sales i.e. there is no change in inventory. • No change in capacity and productivity. By Ghanendra Fago (M. Phil, MBA) For AIM**Break Even analysis**• Break-even analysis is a technique of representing and studying the inter-relationship of the three basic components of CVP: cost, volume and profit. • The break-even analysis determines a relationship between the revenues and costs with respect to volume. • Break-even analysis is always taken as an important part of profit planning as it gives the planner many insights into the data with which he or she is working. • It is a point where the profit is zero as the total revenues are equal to total costs. In other words, it is that level of activity (in units or in Rs.) at which revenue equals cost. By Ghanendra Fago (M. Phil, MBA) For AIM**Methods of CVP Analysis**• Graphic approach • Income statement Approach • Contribution margin or Formula approach • Equation approach By Ghanendra Fago (M. Phil, MBA) For AIM**Sales revenue**250 Total cost Profit 200 BE Point 150 Variable Cost 100 Loss 50 Fixed Cost 150 100 200 250 50 Margin of safety Quantity in units (in 000 units) Graphic Analysis of Break Even Point Cost, Price, Profit (in 000 Rs.) 0 By Ghanendra Fago (M. Phil, MBA) For AIM**By Ghanendra Fago (M. Phil, MBA)**For AIM**Variable Income Statement**By Ghanendra Fago (M. Phil, MBA) For AIM**Contribution Margin Approach Or Formula Approach**• The approach uses the concept of contribution margin and contribution margin ratio. • To find out the number of units to be sold to break-even, the fixed cost can be divided by contribution margin contributed by each unit sold. • Break Even Point (in units) = Fixed cost/CMPU = ….. units = Fixed cost/PV ratio = ….. in Rupees By Ghanendra Fago (M. Phil, MBA) For AIM**Formulae of Cost Volume Profit Analysis**1. Contribution Margin per Unit (CMPU) = Selling Price per unit – Variable cost per unit = Selling Price per unit x PV ratio = Difference in Profit/difference in sales units = Profit/margin of safety units 2. Profit Volume (Contribution margin) Ratio = 1 –CV ratio or = 1- VCPU/SPPU = Difference in Profit/difference in sales revenues = 1- Difference in costs/ difference in sales = Profit/margin of safety rupees 3. Break Even Point (in units) = Fixed cost/CMPU = … units = Fixed cost/PV ratio = ….in Rupees By Ghanendra Fago (M. Phil, MBA) For AIM**4. Required sales to earn desired profit:**Target sales volume to earn profit before tax in rupees = FC+ before tax target profit/Contribution margin ratio Target sales volume to earn profit before tax in units = FC+ before tax target profit/Contribution margin per unit Target sales volume to earn after tax (in rupees) = FC+{(desired profit after tax) / (1-t)}/Contribution margin ratio Target sales volume to earn after tax (in units = FC+{(desired profit after tax) / (1-t)}/Contribution margin per unit By Ghanendra Fago (M. Phil, MBA) For AIM**5. Profit on Sales**= Sales – Variable Cost – Fixed Cost = (Sales Rs. P/V Ratio) – Fixed Cost = (Sales Units CMPU) – Fixed Cost = Margin of Safety CMPU 6. Margin of Safety = Actual Sales – Break Even Sales = Margin of Safety/Actual sales = Profit/CMPU or PV ratio 7. Sales to earn equal profit by two alternative =Differences in fixed costs/difference in PV ratio or CMPU By Ghanendra Fago (M. Phil, MBA) For AIM**Multi Products/Sales Mix**Overall BEP (in Rs.) =Total fixed costs/WAPV ratio =Rs…. Overall BEP (Units) = Total fixed costs/WACMPU = Units By Ghanendra Fago (M. Phil, MBA) For AIM**Weighed Average profit Volume Ratio PV ratio**By Equation: Sales revenues = Fixed costs + variable costs + profitIn units: x = FC + VC + Profit or, x = FC + VC ratio (x) + profit In Rs: Sales price (x) = FC + VC + profit or, sales price (x) = FC + VC rate (x) + profit By Ghanendra Fago (M. Phil, MBA) For AIM**Sensitivity analysis is the measurement of responsiveness in**outcome with the change in determination variables. • As the goal of a business, enterprise is to maximize profits. • Profits are the excess of revenue over the total costs • To measure the sensitivity of CVP factors, the impact of certain percentage of change in volume, price, or cost factor on net profits must take into consideration. Cost Volume Profit Analysis Under Changing Situations - Sensitivity Analysis By Ghanendra Fago (M. Phil, MBA) For AIM**Change in selling price**The change in selling price will affect the profit volume ratio and thus the break-even point. An increase in selling price will increase the PV ratio and will lower the break-even point. The reverse will have opposite effect i.e., decrease in selling price will reduce PV ratio and it results in to higher BEP. By Ghanendra Fago (M. Phil, MBA) For AIM**Change in variable costs**• The change in variable costs has an opposite reaction to the PV ratio i.e. decrease in variable cost result in increase in PV ratio, whereas increase in variable cost shall result in decrease in the PV ratio. A decrease in PV ratio results into higher BEP and reduced profit and vice-versa. By Ghanendra Fago (M. Phil, MBA) For AIM**Change in fixed costs**A change in fixed cost does not have any effect on the PV ratio but it affects the break-even point and ultimately the profit. A decrease shall lower the BEP and increase the profit. Any increase pushes the break-even point and reduces the profits. By Ghanendra Fago (M. Phil, MBA) For AIM