SUBMITTED BY

• NANDITA.N

• REMYA.R.KUMAR

SYNOPSIS

DEFINITIONPROFIT ANALYSIS

PROFIT VOLUME GRAPHEFFECTSUTILITY

LIMITATIONSBREAK EVEN ANALYSIS CHART AND

LIMITATIONS

CVP ANALYSIS

• The analytical technique that is used to study the behavior of profit in response to change in volume, cost and prices is called CVP analysis.

• Cost-Volume-Profit Analysis (CVP), It is a simplified model, useful for short-run decisions.

• A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs).

• Cost-volume-profit analysis employs the same basic assumptions as in breakeven analysis

Assumptions underlying CVP analysis

• Cost segregation : the total cost can be separated in to fixed and variable components.

• Constant unit variable cost : variable cost per unit is constant and total variable cost change in direct proportion to sales volume.

• Constant fixed cost : total fixed cost remains unchanged with changes in sales volume.

• Constant selling price : the selling price per unit remains constant that it does not change with volume or because of other factors.

• Constant sales mix : the firm manufactures only one product or if there are multiple products, the sales mix does not change.

• Synchronized production and sales : inventory level remains the same

The components of Cost-Volume-Profit Analysis are:

• The volume or level of activity is the activity that causes changes in the behaviour of cost. The changes should be correlated with changes in cost

unit selling price is linked directly to profit and includes all costs and expenses pertaining to production and sale of the product

Variable costs are corporate expenses that vary in direct proportion to the quantity of output. Unlike fixed costs, which remain constant regardless of output, variable costs are a direct function of production volume, rising whenever production expands and falling whenever it contracts. Examples of common variable costs include raw materials, packaging, and labour directly involved in a company's manufacturing process.

• A cost that remains unchanged even with variations in output is know as fixed cost.Yotal fixed cost remains constant.

• sales mix • Proportion of total sales which each product or

product line generates, and which needs to be appropriately balanced to achieve the maximum amount of gross profit.

Basic graph • The assumptions of the CVP model yield the following linear equations for total costs

and total revenue (sales):– –

• These are linear because of the assumptions of constant costs and prices, and there is no distinction between Units Produced and Units Sold, as these are assumed to be equal. Note that when such a chart is drawn, the linear CVP model is assumed, often implicitly.

• In symbols:– –

• where• TC = Total Costs • TFC = Total Fixed Costs • V = Unit Variable Cost (Variable Cost per Unit) • X = Number of Units • TR = S = Total Revenue = Sales • P = (Unit) Sales Price • Profit is computed as TR-TC; it is a profit if positive, a loss if negative.

Relationship between tc,sales,profit,loss

• total cost = fixed costs + unit variable cost * amount

describes the total economic cost of production and is made up of variable costs, which vary according to the quantity of a good produced and include inputs such as labor and raw materials, plus fixed costs, which are independent of the quantity of a good produced and include inputs (capital) that cannot be varied in the short term, such as buildings and machinery

PROFIT ANALYSIS

• Profit is affected by change in volume,cost,and prices. This is used to reflect the effect of change in one or more factors on profit.

• CVP analysis is used to reflect the effect of changes in one or more factors on profit.

PROFIT VOLUME GRAPH

• The graph has 2 parts, separated by sales line.

• The upper part of the graph indicates profit.

• Fixed cost are marked on the lower part.

• The amount of fixed cost unrecovered is loss • incurred• Profit line is drawn by joining fixed cost point and• sales line at the breakeven point.

EFFECT OF CHANGE ON PROFITS

• Profits may be effected by changes- increase or decrease in the following factors:

• Selling price• Volume• Variable cost• Fixed cost• A combination of all or any of the above 4

factors

The following data is analyzed to show effect of change in various factors on profit

Budgeted sales volume(100000@Rs 20)

20,00,000

Less budgeted variable cost (100000@Rs 10)

10,00,000

Budgeted contribution 10,00,000

Less budgeted fixed cost

4,00,000

Budgeted net profit 6,00,000

bep 8,00,000

p/v ratio 50%

• The selling price may change because of economic factor or management itself may initiate changes due to increase or decrease in cost or competition or for some other reason. Most cost are controllable and are affected by volume changes. The ultimate impact of changing factors is on the firms profit.

EFFECT OF CHANGE IN PRICE

Change in price

Decrease (20%)

budget Increase(20%)

Units 100000 100000 100000

Selling price

16 20 24

Variable cost

10 10 10

Contribution

6 10 14

Fixed cost 1600000 2000000 2400000

Variable cost

1000000 1000000 1000000

Contribution

600000 1000000 1400000

Fixed cost 400000 400000 400000

Net profit 200000 600000 1000000

Percentage change in profit

-66.7% - +66.7%

p/v ratio 37.5% 50% 58.3%

• An increase in selling price will increase the p/v ratio and as a result it reduces break even point.

• On the contrary decrease in price will reduce p/v ratio and increases break even point.

EFFECT OF VOLUME CHANGES

Change in volume

Decrease(20%)

budget Increase(20%)

Units 80000 100000 120000

Selling price

20 20 20

Variable cost

10 10 10

Contribution

10 10 10

sales 1600000 2000000 2400000

Variable cost

800000 1000000 1200000

Contribution

800000 1000000 1200000

Fixed cost 400000 400000 400000

Net profit 400000 600000 800000

Percentage change in profit

-33.3% - +33.3%

p/v ratio 50% 50% 50%

• A change in volume , not accompanied by change in the selling price and/or cost, will not affect p/v ratio.

• As a result the break even point remains unchanged. Profit will increase with the increase in volume and will be reduced with a decrease in volume.

EFFECT OF PRICE AND VOLUME CHANGES

Change in price

Decrease 20%

Budget Increase 10%

Change in volume

Increase 25%

budget Decrease 15%

Units 125000 100000 85000

Selling price

16 20 22

Variable cost

10 10 10

contribution 6 10 12

sales 2000000 2000000 1870000

Variable cost

1250000 1000000 850000

contribution 750000 1000000 1020000

Fixed cost 400000 400000 400000

Net profit 350000 600000 620000

Percentage change in profit

-41.67% - +33.3%

• A change in price is affected by volume. A price reduction may increase demand of the product and result in increase in volume. Profits may increase with a reduction in price and volume increases substantially and price rise may reduce profits if there is fall in volume.

EFFECT OF VARIABLE COST CHANGES

Change in variable cost

Decrease 20%

budget Increase 20%

Units 100000 100000 100000

Selling price

20 20 20

Variable cost

8 10 12

Contribution

12 10 8

sales 2000000 2000000 2000000

Variable cost

800000 1000000 1200000

contribution 1200000 1000000 800000

Fixed cost 400000 400000 400000

Net profit 800000 600000 400000

Percentage change in profit

+33.3% - -33.3%

• p/v ratio 60%,50%,40%.

• An increase in variable cost will lower the PE ratio , push up the break even point and reduces profit. If the variable cost decreases P/V ratio increases and break even point will be lowered and profits will rise.

EFFECT OF CHANGE IN FIXED COSTS

Change in fixed cost

Decrease 25%

budget Increase 25%

Units 100000 100000 100000

Selling price

20 20 20

Variable cost

10 10 10

Contribution

10 10 10

Sales cost 2000000 2000000 2000000

Variable cost

1000000 1000000 1000000

Contribution

1000000 1000000 1000000

Fixed cost 300000 400000 500000

Net profit 700000 600000 500000

Percentage change in profit

+16.67% - -16.67%

• P/V ratio : 50%,50%,50%

• A change in fixed cost does not influence P/V ratio. Other factors remaining unchanged ,a fall in fixed cost will lower break even point and increases profit

• If total fixed cost is 152000 calculate BEP and profit.

COST VOLUME PROFIT ANALYSIS FOR MULTI PRODUCT FIRM

Product

x y z

Sales 200000 300000 500000

Variable cost

120000 210000 350000

Sales mix

X

20%

Y

30%

Z

50%

Total

100%

Sales revenue

200000 300000 500000 1000000

Variable cost

120000 210000 350000 680000

Contribution

80000 90000 150000 320000

Fixed cost

152000

Net profit 168000

P/V ratio 40% 30% 30% 32%

BEP 152000/0.32=475000

UTILITY OF CVP ANALYSIS

• It is simple device to understand accounting data.

• It is a useful diagnostic tool.

• It provides basic information for further profit improvement studies.

• It is useful method for considering risk implementation of alternative actions.

LIMITATION OF CVP ANALYSIS

• It is difficult to separate cost in to fixed and variable components.

• It is not correct to assume that total fixed cost would remain unchanged over the entire range of volume.

• The assumption of constant selling price and variable cost is not valid.

• It is difficult to use break even analysis

• For multi product firm.

• The break even analysis is a short run concept and has a limited use in long range planning.

• The break even analysis is static tool.

• BEP analysis is a specific way of studying the interrelationship between cost, volume and profit.

• BEP analysis establishes relationship between revenues, cost with respect to volume,

• The significant aspect of CVP analysis is to examine the effects of change in cost, volume and price on profits.

Break even chart

• This chart portrays a pictorial view of the relationship between cost, volume, profit.

• The BEP indicated in the chart will be one at which total cost line and total sales lines intersects.

• Estimated sales : 20,00,000

• Less :Variable cost : 12,00,000

• Contribution : 8,00,000

• Less : Fixed cost : 4,00,000

• Net profit : 4,00,000

• Intersection between sales and total cost is the BEP.

• The angle formed by intersection of sales and total cost line is known as angle of incidence. Larger the angle lower will be the BEP and vice versa.

• Margin of safety : the excess of actual or budgeted sales over break even sales

• Margin of safety indicates the extent to which sales may fall before the firm suffers a loss.

• A low margin of safety may result for a firm which has low contribution.

• If both margin of safety and P/V ratio are low the firm must think of increasing selling price

• Margin of safety = sales- BE sales/sales

• BE sales = fixed cost/contribution

Limitationsof break even analysis

• Break-even analysis is only a supply side (i.e. costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices.

• It assumes that fixed costs (FC) are constant

• It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. (i.e. linearity)

• It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period).

• In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant (i.e., the sales mix is constant).