Topic 6

Cost-Volume-Profit
(CVP)
Analysis
Basic Assumptions

∆ in Prod/Sales volume = sole cause for cost and
revenue ∆

Total Costs = Fixed Costs + Variable Costs

Revenue & costs = linear function (straight line)

SP, VC/U, FC = known & constant

Only single product will be analyzed. If multiple

products, relative sales % are known & constant

Time value of money (interest) ignored

3-2
Basic Formulae

TOTAL
OPERATING REVENUES PRE-PAID
= - CGS -
INCOME from OPEX
OPERATIONS

OPERATING INCOME
NET INCOME = -
INCOME TAX

3-3
Contribution Margin

Contribution Margin:
CM = Sales – VC

Contribution Margin per unit:
CMU= SPu – VCu

Contribution Margin also
CM = CMu x Q

Contribution Margin Ratio (%)
CMR = CMu ÷ SP
3-4
Contribution Margin
Income Statement Derivations

A horizontal presentation of the Contribution
Margin Income Statement:

Sales – VC – FC = Operating Income (OI)

(SP x Q) – (VCu x Q) – FC = OI

Q (SP – VCu) – FC = OI

Q (CMu) – FC = OI
3-5
 # OF PACKAGES SOLD
0 1 5 10 25 30 40 50
REVENUES $200 $0 $200 $1,000 $2,000 $5,000 $6,000 $8,000 $10,000

CVP, Graphically VARIABLE COSTS

CONT.MARGIN
FIXED COSTS
OPINC
$120
$80
$0
$0
$120
$80
$600
$400
$2,000 $2,000 $2,000 $2,000
-$2,000 -$1,920 -$1,600
$1,200
$800
$2,000
-$1,200
$3,000
$2,000
$2,000
$0
$3,600
$2,400
$2,000
$400
$4,800 $6,000
$3,200 $4,000
$2,000 $2,000
$1,200 $2,000
CONT.MARGIN % 40%

Total
revenues Operating
Breakeven point = 25 units line income
Operating
income area

Variable
costs
Total
Total costs Breakeven
costs line point
line = 25 units

Operating
loss area
Fixed
Operating
loss area
costs

3-6
Breakeven Point

Recall the last equation in an earlier slide:
Q (CMu) – FC = OI

A simple manipulation of this formula, and
setting OI to zero will result in:
Breakeven Point (quantity):
BEQ = FC ÷ CMu

At this point, a firm has no profit or loss at
the given sales level

3-7
Breakeven Point, continued

If per-unit values are not available, the
Breakeven Point may be restated in its
alternate format:
BE Revenues = FC ÷ CMR

3-8
Breakeven Point, extended:
Profit Planning

With a simple adjustment, the Breakeven
Point formula can be modified to become a
Profit Planning Tool

Profit is now reinstated to the BE formula,
changing it to a simple sales volume equation
Q = (FC + OI)
CM

3-9
CVP and Income Taxes

From time to time it is necessary to move back and forth

between pre-tax profit (OI) and after-tax profit (NI),
depending on the facts presented

After-tax profit can be calculated by:
OI x (1-Tax Rate) = NI

NI can substitute into the profit planning equation
through this form:
OI = I I NI I
(1-Tax Rate)

3-10
Sensitivity Analysis

CVP provides structure to answer a variety of
“what-if” scenarios

“What” happens to profit “if”:

Selling price changes

Volume changes

Cost structure changes

Variable cost per unit changes

Fixed cost changes

3-11
Margin of Safety

One indicator of risk, the Margin of Safety
(MOS) measures the distance between
budgeted sales and breakeven sales:
MOS = Bud. (or Actual) Sales – BE Sales

MOS Ratio removes the firm’s size from the
output, and expresses itself in the form of a
percentage:
MOS Ratio = MOS ÷ Budgeted Sales

3-12
 Operating Leverage

Operating Leverage (OL) = effect that fixed

costs have on changes in operating income as
changes occur in units sold, expressed as
changes in contribution margin

OL = Contribution Margin
Operating Income

Notice these two items are identical, except for

fixed costs
3-13
Effects of Sales-Mix on CVP

The formulae presented to this point have assumed a
single product is produced and sold

A more realistic scenario involves multiple products
sold, in different volumes, with different costs

For simplicity’s sake, only two products will be
presented, but this could easily be extended to even
more products

3-14
Effects of Sales-Mix on CVP

A weighted-average CM must be calculated (2
products)

(P1CMU x P1Q) + (P2CMU x P2Q)

WA-CMU =
(Q1 + Q2)

This new CM would be used in CVP equations

FIXED COSTS
MULTI - PROD BE =
WA - CMU

3-15
Multiple Cost Drivers

Variable costs may arise from multiple cost
drivers or activities.

A separate variable cost for each driver.

Examples include:

Customer or patient count

Passenger miles

Patient days

Student credit-hours

3-16
Contribution Margin vs.
Gross Profit Comparative Statements

Contribution Margin Income Statement Financial Accounting Income Statement

(Internal-Use Only) GAAP - Based

Revenues: $200 Revenues: $200

Less: Less:
Variable Cost of Goods Sold $120 Cost of Goods Sold $120
Variable Operating Costs 45 165
Contribution Margin 35 Gross Margin (Profit) 80
Fixed Operating Costs 20 Fixed & Variable Operating Costs 65
Operating Income $15 Operating Income $15

3-17