4- CVP Analysis-Break Even Analysis (2)

7/30/2019 4- CVP Analysis-Break Even Analysis (2)

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Cost- Volume- Profit Analysis

(CVP Analysis)

It is a technique that may be used by themanagement to evaluate how costs and profitsare affected by the changes in the volume of

business and activities. It focuses attention on the short run effect only

because in the short run (period of one year orless), the level of output is restricted to that

available from the current operating capacity. Some inputs can be changed in the short run but

others may not.


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What would be the effect on profits if the sellingprice is reduced/or more units are sold?

What is the level of sales at which the firm willjust break even and will not be earning anyprofit?

What level of sales must be achieved to earn a

desired level of profit? What sales level is required to meet additional

fixed costs?

What is the most profitable sales mix?

What will be the effect of offering a salescommission to salesman on the profit of thefirm?


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CVP analysis deals with the prices, cost

structure and the sales volume and identifiesthe profit figure with one or other

combination of these variables.

So the key elements are selling prices, sales

volume, variable cost per unit, total fixed costs

and the sales mix.

Two techniques of CVP analysis are:

(i) Contribution Margin Analysis

(ii) Break Even Analysis


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Sales

(-) Variable Cost

Contribution

(-) Fixed Cost

Profit

Contribution Margin (CM) = Sales- Variable CostContribution is available to recover fixed costs andafter they are recovered, to contribute to the profit ofthe firm.

Contribution Margin Ratio = Contribution p.u. x 100

Selling Price p.u.

CM Ratio is also known as Profit Volume Ratio (PV Ratio)or Contribution to Sales Ratio.


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But the CM must not be confused with Gross

Profit. Their calculation and their purpose areabsolutely different.

CM Ratio is used by the management to

analyse the effect of change in sales volumeon the profit figure. If the CM or PV Ratio is

low, the effect of increased sales volume on

profit will be small but if the CM Ratio is high,this effect will be substantial.


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Break Even Analysis

It is the fundamental technique of CVP Analysis.

CM is available to recover fixed costs and togenerate profits. But the fixed costs remainconstant during a given period, so the firm mustsell enough units to generate sufficient total CMwhich is at least equal to the total fixed cost.

The Break Even Point (BEP) is the sales level atwhich the CM is just equal to the fixed cost, and

the firm has no profit no loss. Any sales level below BEP results in loss and any

sales level above BEP results in profit.


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Assumptions of BEP Analysis

1. All costs can be separated into fixed and variablecomponents.

2. Variable cost per unit remains constant and totalvariable cost varies in direct proportion to thevolume of production

3. Total fixed cost remains constant.

4. Selling price per unit does not change as volumechanges

5. There is synchronization between productionand sales i.e. volume of production equalsvolume of sales.


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Break Even Point (BEP) may be defined as that point of sales volume at

which total revenue is equal to total cost. It is a point of no profit, no loss.

At this point, contribution equals the fixed costs. If production/sales is

increased beyond this level, there shall be profit to the organisation and if

it decreases from this level, there shall be loss to the organisation.

CALCULATION IN BREAK-EVEN ANALYSIS

Break Even Point (in units) = Total fixed cost = F

Contribution per unit S V

Break Even Point (in Rupees)= Total fixed cost X S.P.p.u. = F X SContribution per unit S V

or

Break Even Point (in Rupees) = Total Fixed cost

P/V Ratio

Calculation of Break-Even Point


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Application of P/V Ratio

1. BEP = Fixed cost

P/V Ratio

Fixed cost = Sales (P/V Ratio) Profit

2. Contribution = S x P/V ratio

3. Variable cost at given sales

VC = S (1 P/V Ratio)

4. Fixed Cost at a given sales volume

FC = S (P/V Ratio)

Profit

5. Determination of profit or loss

a. When sales, fixed cost and P/V ratio given

Profit = Sales (P/V ratio) fixed cost


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(b) When sales and Break Even sales given

Profit = P/V ratio (Sales Break even sales)

Or

Profit = P/V ratio x Margin of safety*

*(Margin of safety = Sales break even sales)

6. Determination of sales volume to produce desired profit

Sales volume = fixed cost + Desired profit

P/V Ratio


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Other Types of BEP

Cash Break Even Point: It is a point or level of output/sales where thecash inflow will be just equal to the cash required to dischargeimmediate cash liabilities.

Break Even Point (in units)= Cash fixed cost + Loan instalment

Contribution per unitBreak Even Point (in Rupees)=Cash fixed cost+ Loan instalment X SP

Contribution per unit

or

Break Even Point (in Rupees)= Cash Fixed cost+Loan instalment

P/V Ratio


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Combined BEP: BEP of the firm producing many types ofproducts can be calculated collectively.

Combined BEP= Fixed Expenses for all products

Overall P/V Ratio

Cost BEP: It indicates a situation where the costs ofoperating two alternatives are equal. It helps to

identify which is the best to operateCost BEP= Difference in Fixed Cost

Difference in Variable Cost per unit

At this level both the alternatives are equally profitable,

but the alternative with higher fixed cost will be moreprofitable for volume above this level and thealternative with lower fixed cost will be moreprofitable for volume below this level.


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BEP as a percentage of Installed Capacity:

It shows how much of the installed capacity shouldbe used to attain the situation of BEP.

Capacity BEP= BEP x100

Installed Capacity

Required sales for a certain percentage of profitRequired Sales (X)

= Fixed Cost+ (X x %of profit on sales)

P/V Ratio

Or = Fixed Cost___________

S.P.p.u.- (V.C.p.u.+ Desired Profit p.u.)

4- CVP Analysis-Break Even Analysis (2)

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