CHAPTER

Cost-VolumeProfit Analysis:
A Managerial
Planning Tool

Cost-Volume-Profit Relationships
To manage any size business you must understand:
how costs respond to changes in sales volume
the effect of costs and revenues on profits.

Cost-Volume-Profit (CVP) Analysis

What is cost-volume-profit analysis?

The study of the effects of changes in costs

and volume on a companys profits.

Break-Even Point

The break-even point is

the level of sales at which
revenue equals total cost
(both fixed & variable)
and net income is zero.

Can be expressed in sales

dollars or sales units.

Is useful to management
in deciding whether:

Sales above the

breakeven point
provide a profit.

Sales below the

breakeven point
result in a loss.

To add new product lines

Change sales prices on current

products

To enter new markets

Break-Even Point
Two basic techniques for computing break-even point:
1. Equation

Profits = Sales (Variable expenses + Fixed expenses)

OR at BEP

Sales -Variable expenses = Fixed expenses

2. Contribution margin
Break-even
sales

Fixed
= costs

Contribution
margin

Contribution Margin Income Statement

CM
is
amount
remaining
from
sales
rev
after
variable exp have
been deducted.
CM goes to cover
fixed expenses.

Total Per Unit

Sales (50,000 units)

$1,000,000 $20
Variable costs
600,000
12
Contribution margin
$400,000 $ 8
Fixed costs
300,000
Income from operations $100,000

Percent

100%
60%
40%

Unit Contribution Margin

After
covering
fixed costs, any
remaining
CM
contributes
to
income.

calculated
as
unit
selling price minus unit
variable cost.

Contribution Margin Ratio

calculated as contribution
margin per unit divided by
unit SP

CASE STUDY WIND BICYCLE

WIND BICYCLE CO.

Contribution Income Statement
For the Month of June
Total
Per Unit
Sales (500 bikes)
$ 250,000
$ 500
Less: variable expenses
150,000
300
Contribution margin
100,000
$ 200
Less: fixed expenses
80,000
Net income
$ 20,000

For
each
additional
unit
Wind sells, $200
more
in
contribution margin
will help to cover
fixed expenses and
profit.

Each

month
Wind
must
generate
at
least $80,000
in total CM to
break even.

CASE STUDY WIND BICYCLE

If Wind sells 400 units in a

month, it will be operating at

the break-even point.

WIND BICYCLE CO.

Contribution Income Statement
For the Month of June
Total Per Unit
Sales (400 bikes)
$ 200,000 $ 500
Less: variable expenses 120,000
300
Contribution margin
80,000 $ 200
Less: fixed expenses
80,000
Net income
$
0
BEP in
= 80,000 =2,00,000
total sales dollars
0.40
CM Ratio = Contribution margin
Sales

If Wind sells one additional unit

(401 bikes), net income will

increase by $200.
WIND BICYCLE CO.
Contribution Income Statement
For the Month of June
Total
Per Unit
Sales (401 bikes)
$ 200,500 $ 500
Less: variable expenses
120,300
300
Contribution margin
80,200 $ 200
Less: fixed expenses
80,000
Net income
$ 200
Contribution Margin Method
Break-even point
in units sold

80,000 = 400
200

The Margin of Safety

Excess of budgeted (or actual) sales over the break-even volume of
sales. The amount by which sales can drop before losses begin to be
incurred.

MOS = Sales Sales at BEP

Sales
Sales
Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

A Sales
Break-even sales
B Excess
Margin of safety (B/A)

Break-even
sales
400 units
$ 200,000
120,000
80,000
80,000
$
-

Actual sales
500 units
$ 250,000
150,000
100,000
80,000
$
20,000

Dollars Units x pu
price
$250,000 500 x $ 200 = 100,000
200,000 400 x $ 200 = 80,000
$ 50,000
20,000
20%

Margin of safety indicates the decrease in

sales that may occur before an operating
loss results.

Margin of safety
expressed in units.

DECISION 1 FIXING SALES WITH TARGET PROFIT

Equation Method
We can determine the number
of bikes that must be sold to
earn a profit of $100,000
using the equation method.
IF TARGET PROFIT IS $
100,000, bikes required to
breakeven
$500Q = $300Q + $80,000
+ $100,000

Contribution Margin Approach

We can also determine the number
of bikes that must be sold to earn
a profit of $100,000 using the
contribution margin approach.
Units sold to attain
the target profit

Fixed expenses + Target profit

Unit contribution margin

$80,000 + $100,000
$200

$200Q = $180,000
= 900 bikes
Q = 900 bikes

Fixed costs plus

the target profit
equals the
required total
contribution
margin.

DECISION 2 - TRACKING Changes in Fixed

Costs and Sales Volume
Wind is currently selling 500 bikes per month. The companys sales
manager believes that an increase of $10,000 in the monthly advertising
budget would increase bike sales to 540 units.
Should we authorize the requested increase in the advertising budget?
The Shortcut Solution

Increase in CM (40 units X $200) $ 8,000

Increase in advertising expenses 10,000
Decrease in net income
$ (2,000)
Sales increased by $20,000,
but net income decreased by
$2,000.
$80,000 + $10,000 advertising = $90,000

Current Sales Projected Sales

(500 bikes)
(540 bikes)
Sales
$ 250,000 $ 270,000
Less: variable expenses
150,000
162,000
Contribution margin
100,000
108,000
Less: fixed expenses
80,000
90,000
Net income
$ 20,000 $
18,000

DECISION 3 - TRACKING EFFECTS OF

PRICE CHANGES
CHANGES IN PRICE

DECREASE (20% )

BUDGET

INCREASE (20% )

100000

100000

100000

SELLING PRICE (RS)

16

20

24

VARIABLE COST (PER UNIT (RS)

10

10

10

10

14

RS

RS

RS

SALES

1600000

2000000

2400000

VARIABLE COST

1000000

1000000

1000000

CONTRIBUTION

600000

1000000

1400000

FIXED COST

400000

400000

400000

NET PROFIT

200000

600000

1000000

% CHANGE IN PROFIT

-66.67%

P/V RATIO

37.50%

50.00%

58.33%

BEP

1066667

800000

685714

UNITS

CONTRIBUTION PER UNIT (RS)

ITEMS

CONTRIB

PV RATIO

SP >
VC <
SP <
FC >
FC <

>
<
<
>
<

>
<
<
=
=

MOS

HIGH
LOW
LOW
LOW
HIGH

66.67%

BEP

PROFIT
BEYOND BEP

LOSS BELOW
BEP

<
<
>
>
<

>
>
<
<
>

<
<
>
>
<

PROVIDED
VARIABLE COST IS
FIXED

DECISION 4 - TRACKING EFFECTS OF

VARIABLE COST CHANGES
CHANGES IN VARIABLE COST

DECREASE (20% ) BUDGET INCREASE (20% )

UNITS

100000

100000

100000

20

20

20

10

12

12

10

RS

RS

RS

SALES

2000000

2000000

2000000

VARIABLE COST

800000

1000000

1200000

CONTRIBUTION

1200000

1000000

800000

FIXED COST

400000

400000

400000

NET PROFIT

800000

600000

400000

% CHANGE IN PROFIT

33.33%

P/V RATIO

60.00%

50.00%

40.00%

BEP

666667

800000

1000000

SELLING PRICE (RS)

VARIABLE COST (PER UNIT (RS)
CONTRIBUTION PER UNIT (RS)

ITEMS

CONTRIB

PV RATIO

SP >
VC <
SP <
FC >
FC <

>
>
<
>
<

>
>
<
=
=

MOS

HIGH
HIGH
LOW
LOW
HIGH

-33.33%

BEP

PROFIT
BEYOND BEP

LOSS BELOW
BEP

<
<
>
>
<

>
>
<
<
>

<
<
>
>
<

PROVIDED
SELLING PRICE IS
FIXED

DECISION 4 - TRACKING EFFECTS OF

FIXED COST CHANGES
CHANGES IN FIXED COST

DECREASE (25% ) BUDGET INCREASE (25% )

UNITS

100000

100000

100000

SELLING PRICE (RS)

20

20

20

VARIABLE COST (PER UNIT (RS)

10

10

10

CONTRIBUTION PER UNIT (RS)

10

10

10

RS

RS

RS

SALES

2000000

2000000

2000000

VARIABLE COST

1000000

1000000

1000000

CONTRIBUTION

1000000

1000000

1000000

FIXED COST

300000

400000

500000

NET PROFIT

700000

600000

500000

% CHANGE IN PROFIT

16.67%

P/V RATIO

50.00%

50.00%

50.00%

BEP

600000

800000

1000000

BEP

PROFIT
BEYOND BEP

LOSS BELOW
BEP

<
<
>
>
<

>
>
<
<
>

<
<
>
>
<

ITEMS

CONTRIB

PV RATIO

SP >
VC <
SP <
FC >
FC <

>
<
<
=
=

>
<
<
=
=

MOS

HIGH
LOW
LOW
LOW
HIGH

-16.67%

PROVIDED
SELLING PRICE &
VARIABLE COST
IS FIXED

DECISION 5 - TRACKING EFFECTS OF

VOLUME CHANGES
CHANGES IN VOLUME

DECREASE (20% ) BUDGET INCREASE (20% )

UNITS

80000

100000

120000

SELLING PRICE (RS)

20

20

20

VARIABLE COST (PER UNIT (RS)

10

10

10

CONTRIBUTION PER UNIT (RS)

10

10

10

RS

RS

RS

SALES

1600000

2000000

2400000

VARIABLE COST

800000

1000000

1200000

CONTRIBUTION

800000

1000000

1200000

FIXED COST

400000

400000

400000

NET PROFIT

400000

600000

800000

% CHANGE IN PROFIT

-33.33%

P/V RATIO

50.00%

50.00%

50.00%

BEP

800000

800000

800000

33.33%

A CHANGE IN VOLUME , NOT ACCOMPANIED WITH CHANGE IN SELLING

PRICE OR COST WILL NOT AFFECT PV RATIO
THUS BEP REMAINS UNCHANGED
PROFIT INCRESAES WITH INCREASE IN VOLUME & VICE VERSA
THUS THE EFFECT OF PRICE CHANGES ON PROFIT IS GREATER THAN
THE EFFECT OF CHANGE IN VOLUME (SEE PREVIOUS SLIDE)

DECISION 6 - TRACKING EFFECTS OF

VOLUME & PRICE CHANGES
CHANGES IN PRICE

DECREASE (20% ) BUDGET INCREASE (10% )

CHANGES IN VOLUMES

INCREASE (25% )
125000

100000

DECREASE
(15% )
85000

SELLING PRICE (RS)

16

20

22

VARIABLE COST (PER UNIT (RS)

10

10

10

10

12

RS

RS

RS

SALES

2000000

2000000

1870000

VARIABLE COST

1250000

1000000

850000

CONTRIBUTION

750000

1000000

1020000

FIXED COST

400000

400000

400000

NET PROFIT

350000

600000

620000

% CHANGE IN PROFIT

-41.67%

P/V RATIO

37.50%

50.00%

54.55%

BEP

1066667

800000

733333

UNITS

CONTRIBUTION PER UNIT (RS)

3.33%

DECISION 7 - TRACKING EFFECTS OF CHANGES IN A

COMBINATION OF FACTORS
CHANGES IN PRICE

INCREASE (20% ) BUDGET

CHANGES IN VOLUMES

DECREASE (25% )

CHANGE IN VARIABLE COST

INCREASE (10% )

CHANGE IN FIXED COST

UNITS

DECREASE
(20% )(25% )
INCREASE
DECREASE
(10% ) (5% )
DECREASE

INCREASE (5% )
75000

100000

125000

SELLING PRICE (RS)

24

20

16

VARIABLE COST (PER UNIT (RS)

11

10

CONTRIBUTION PER UNIT (RS)

13

10

RS

RS

RS

SALES

1800000

2000000

2000000

VARIABLE COST

825000

1000000

1125000

CONTRIBUTION

975000

1000000

875000

FIXED COST

420000

400000

380000

NET PROFIT

555000

600000

495000

% CHANGE IN PROFIT

-7.50%

P/V RATIO

54.17%

50.00%

43.75%

BEP

775385

800000

868571

-17.50%

NONE OF THE TWO PLANS ARE PROFITABLE FOR THE FIRM

DECISION IN CASE OF MULTI PRODUCT FIRM

EARLIER SALES MIX CONSTANT
IN CASE OF MULTI PRODUCT
CONTRIBUTION FOR EACH PRODUCT TO BE FOUND

BEP OF EACH PRODUCT CAN BE FOUND ONLY WHEN TFCs ARE

DISTRIBUTED & FIXED COST FOR EACH PRODUCT KNOWN
(PRACTICAL DIFFICULTIES, THUS NEVER FOLLOWED)
FIRMS PV RATIO IS WEIGHTED AV OF P/V RATIOS OF ALL
PRODUCTS, WEIGHTS BEING RELATIVE PROPORTION OF EACH
PRODUCTS SALES

PRODUCT

SALES MIX

20%

30%

50%

SALES REVENUE

200000

300000

500000

1000000

VARIABLE COST (PER UNIT (RS)

120000

210000

350000

680000

80000

90000

150000

320000

CONTRIBUTION PER UNIT (RS)

TOTAL
100%

FIXED COST

152000

NET PROFIT

168000

P/V RATIO
BEP FOR FIRM

40.00%

30.00%

30.00%

32.00%
475000

DECISION-8 EFFECT OF CHANGE IN SALES MIX

A CHANGE IN PRODUCT MIX WILL CHANGE BEP & PROFIT WHEN
PRODUCTS HAVE UNEQUAL P/V RATIO & VICE VERSA
EFFECT OF CHANGE IN SALES
MIX
PRODUCT

50%

30%

20%

SALES REVENUE

500000

300000

200000

1000000

VARIABLE COST (PER UNIT (RS)

300000

210000

140000

650000

CONTRIBUTION PER UNIT (RS)

200000

90000

60000

350000

SALES MIX

TOTAL
100%

FIXED COST

152000

NET PROFIT

198000

P/V RATIO
BEP FOR FIRM

40.00%

30.00%

30.00%

35.00%
434285.7

BEP CAME DOWN

P/V RATIO IMPROVED BECAUSE SALES OF LESS PROFITABLE PRODUCT
Z WERE SHIFTED IN FAVOUR OF MORE PROFITABLE PRODUCT X
MANAGEMENT SHOULD STRESS PRODUCTS WITH LARGEST P/V RATIO
FIXED COST NOT ALLOCATED TO INDIVIDUAL PRODUCT AS EFFCETS OF
VARIOUS FACTORS ON BEP & PROFIT RATHER DEPENDS UPON
CONTRIBUTION MADE BY EACH PRODUCT

DECISION 9 SELECTION OF PRODUCT MIX

BASED ON PRINCIPLE OF PROFIT MAXIMISATION
PRODUCTS RANKED IN ORDER OF CONTRIBUTION
PRODUCT WHICH CONTRIBUTES HIGHEST GIVEN TOP RANKING
NUMBER OF UNITS THAT CAN BE SOLD
PARTICULARS
A1 A2 A3
IN THE MARKET
SELLING PRICE PER UNIT 100 80 60
A1 = 20,000
A2 = 15000
VARIABLE COSTS
A3 = 10000
RAW MATERIALS
30 40 25
FIXED COST = RS 10,00,000
TOTAL CONTRIBUTION DERIVED
WAGES
25 10 8
A1 = 20,000 X 35
=
700000
DIRECT EXPENSES
5
8
2
A3 = 15000 X 23
=
345000
OVERHEADS
5
2
2
A2 = 10000 X 20
=
200000
TOTAL
1245000
TOTAL
65 60 37
CONTRIBUTION

35

20

23

RANK

THUS THE COMPANY CAN EARN A

PROFIT OF 245000 AFTER RECOVERING
FIXED COST OF RS 1000000

WHEN ALL PRODUCTS HAVE POSITIVE CONTRIBUTION, ALL OF THEM

CAN BE PRODUCED IN ORDER OF RANKING IF THERE IS NO CAPACITY &
RESOURCE CONSTRAINT

DECISION 10- CAPACITY & RESOURCE SCARCITY

IF THERE IS CAPACITY & RESOURCE SCARCITY , SELECTION OF

PRODUCT MIX SHOULD AIM AT MAXIMISING PROFIT WITHIN

AVAILABLE RESOURCES
ASSUME MAXIMUM PRODUCTION CAPACITY IS 30000 UNITS. WHAT
SHOULD BE THE PRODUCT MIX
PARTICULARS

A1

A2 A3

SELLING PRICE PER UNIT 100 80

60

VARIABLE COSTS
RAW MATERIALS

30

40

25

WAGES

25

10

DIRECT EXPENSES

OVERHEADS

TOTAL

65

60

37

CONTRIBUTION

35

20

23

RANK

NUMBER OF UNITS THAT CAN BE SOLD

IN THE MARKET
A1 = 20,000
A2 = 15000
A3 = 10000
FIXED COST = RS 10,00,000
TOTAL UNITS TO BE PRODUCED NOW
PRODUCE A1 = 20,000 X 35 =700000
PRODUCE A3 = 10000 X 23 =230000
TOTAL
= 930000
FIXED COST
= 1000000
LOSS
= (70000)
UNLESS THE COMPANY INCREASES THE
CAPACITY , IT CANT SURVIVE IN THE
LONG RUN WITH THE EXISTING COST
VOLUME RELATIONSHIP

DECISION 11- VOLUME CONSTRAINT

IN CASE OF VOLUME CONSTRAINT P/V RATIO IS THE GUIDING FACTOR

FOR SELECTION OF PRODUCT MIX

ASSUME THAT THERE IS ONLY VOLUME RESTRICTION TO THE

EXTENT OF RS 4,00,000
PRODUCT HAVING HIGHEST PV RATIO SHOULD BE GIVEN PRIORITY

OVER THE OTHERS & SO ON

PARTICULARS

A1

A2

A3

SELLING PRICE 100 80

60

CONTRIBUTION 35

20

23

P/V RATIO (%)

35

25

36.33

RANK

ACCORDING PRODUCT A3 IS THE BEST

CHOICE

DECISION 12- CAPACITY & VOLUME

CONSTRAINT
IF VOLUME RESTRICTION IS TO BE ADJUSTED WITHIN MAXIMUM

PRODUCTION CAPACITY, CAPACITY BOTTLENECK SHOULD

SATISFIED WHILE ARRIVING AT A PROPER PRODUCT MIX.

BE

ASSUME THAT OVER & ABOVE THE VOLUME RESTRICTION OF RS 30

LAKHS, PRODUCT WISE QUANTITATIVE RESTRICTION IS 20,000 UNITS

OF A1, 15000 UNITS OF A2 & 10,000 UNITS OF A3 WITH OVERALL
QUANTITATIVE RESTRICTION OF 35,000 UNITS. SELECT THE
APPROPRIATE PRODUCT MIX.
PARTICULARS
P/V RATIO (%)
MAXIMUM SALES
SALES OF A3 (10000 UNITS @ RS 60 PER UNIT)
BALANCE OF VOLUME
SALES OF A1 (20000 X RS 100)
BALANCE
SALES OF A2 (400000/80 = 5000 UNITS )
SO PRODUVCT MIX IS A1 = 20,000 UNITS
A2 = 5000 UNITS
A3 = 10000 UNITS
TOTAL = 35000 UNITS

A1
35

A2
25

A3
36.33

TOTAL VOL
30,00,000

600000
2400000

2000000
400000
400000

DECISION 13- CONTRIBUTION OF

LIMITING FACTOR
THERE MAY BE SCARCITY OF RAW MATERIAL
TERMED AS LIMITING FACTOR OR KEY FACTOR
THEN HERE IS CONTRIBUTION PER UNIT OF LIMITING FACTOR IS THE

GUIDING FACTOR WHILE SELECTING PRODUCT MIX.

ASSUME FURTHER, THAT A1 CONSUMES 6 KG OF MATERIAL FOR ONE

UNIT OF OUTPUT, A2 CONSUMES 8 KG & A3 CONSUMES 5KG. THERE IS

RAW MATERIAL QUOTA OF 180000 KG. WHAT SHOULD BE THE
PRODUCT MIX?
PARTICULARS
CONTRIBUTION PER UNIT
MATERAIL INPUT PER UNIT OF OUTPUT (KG)
CONTRIBUTION PER KG OF MATERIAL (RS)
Ranking

A1
35
6
35/6=5.83
1

A2
20
8
20/8=2.50
3

A3
23
5
23/5=4.60
2

NOW LET US PUT QUANTITAIVE RESTRICTIONS

PRODUCT MIX
PRODUCT
MATERIAL CONS (KG)
UNITS
A1
120000
20000
A3
50000
10000
A2
10000
(10000/8) 1250

The Limitations of CVP Analysis

Selling price & cost is known & constant
throughout the entire relevant range.
Analysis assumes linear revenue function and
linear cost function throughout the entire relevant
range.
In multi-product companies, the sales mix is
constant & known.
In manufacturing companies, inventories do not
change (units produced = units sold).

CONTRIBUTION & LTG FACTOR ANALYSIS

AB MANUFCATURES & SELLS TWO PRODUCTS A & B.

SELLS 600 UNITS OF A & B AT RS 23 & 19 RESPECTIVELY

COST ST. IS AS UNDER

A
DIRECT MATL
2.00
DIRECT LABOUR
4.00
FACTORY OVHDS (40% FXD) 5.00
OTHER OVHD (40% VBLE)
8.00
TOTAL
19.00

B
4.00
4.00
3.00
5.00
16.00

FACTORY OVHDS ABSORBED ON BASIS OF MCH HRS WHICH IS LTD FACTOR.

MCH HR IS 2 .5 PER HR FOR A & 1.5 FOR B
AB RECVD OFFER TO SELL PRODUCT A @ RS 17.50 & B AT RS 15.50.
CO. HAS SPARE CAPACITY OF 25% & CAN SUPPLY EITHER A OR B
WHICH OFFER IS TO BE ACCEPTED.
NOTE: Fxd Cost per unit reflects only allocated costs & is irrelevant for decsion making