Chapter 1 Introduction

Cost–volume–profit (CVP), in managerial economics, is a form of cost accounting.

It is a simplified model, useful for elementary instruction and for short-run

decisions.

CVP analysis expands the use of information provided by break-even analysis. A

critical part of CVP analysis is the point where total revenues equal total costs

(both fixed and variable costs). At this break-even point, a company will

experience no income or loss. This break-even point can be an initial examination

that precedes more detailed CVP analysis.

CVP analysis employs the same basic assumptions as in breakeven analysis. The

assumptions underlying CVP analysis are:

The behavior of both costs and revenues is linear throughout the relevant range

of activity. (This assumption precludes the concept of volume discounts on

either purchased materials or sales.)

Costs can be classified accurately as either fixed or variable.

Changes in activity are the only factors that affect costs.

All units produced are sold (there is no ending finished goods inventory).

1

When a company sells more than one type of product, the product mix (the

ratio of each product to total sales) will remain constant.

To know the cost, volume and profit relationship, a study of the following

is essential :

(1) Marginal Cost Formula

(2) Break-Even Analysis Marginal Costing and Cost Volume Profit Analysis

(3) Profit Volume Ratio (or) PN Ratio

(4) Profit Graph

(5) Key Factors and

(6) Sales Mix

Objectives of Cost Volume Profit Analysis

The following are the important objectives of cost volume profit analysis:

(1) Cost volume is a powerful tool for decision making.

(2) It makes use of the principles of Marginal Costing.

2

(3) It enables the management to establish what will happen to the financial

results if a specified level of activity or volume fluctuates.

(4) It helps in the determination of break-even point and the level of output

required to earn a desired profit.

(5) The PN ratio serves as a measure of efficiency of each product, factory,

sales area etc. and thus helps the management to choose a most profitable line

of business.

(6) It helps us to forecast the level of sales required to maintain a given amount

of profit at different levels of prices.

Marginal Cost Equation

The Following are the main important equations of Marginal Cost :

Sales = Variable Cost + Fixed Expenses ± Profit/Loss

Contribution = Fixed Cost + Profit

The above equation brings the fact that in order to earn profit the contribution

must be more than

fixed expenses. To avoid any loss, the contribution must be equal to fixed cost.

3

Contribution

The term Contribution refers to the difference between Sales and Marginal Cost

of Sales. It also termed as "Gross Margin." Contribution enables to meet fixed

costs and profit. Thus, contribution will first covered fixed cost and then the

balance amount is added to Net profit. Contribution can be represented as:

Contribution = Sales - Marginal Cost

Contribution = Sales - Variable Cost

Contribution = Fixed Expenses + Profit

Contribution - Fixed Expenses = Profit

Sales - Variable Cost = Fixed Cost + Profit

The components of CVP analysis are:

Level or volume of activity

Unit selling prices

Variable cost per unit

Total fixed costs

4

CVP assumes the following

Constant sales price

Constant variable cost per unit

Constant total fixed cost

Constant sales mix

its sold equal units produced.

These are simplifying, largely linearizing assumptions, which are often implicitly

assumed in elementary discussions of costs and profits. In more advanced

treatments and practice, costs and revenue are nonlinear and the analysis is more

complicated, but the intuition afforded by linear CVP remains basic and useful.

One of the main methods of calculating CVP is profit–volume ratio which is

(contribution /sales)*100 = this gives us profit–volume ratio.

contribution stands for sales minus variable costs.

Therefore it gives us the profit added per unit of variable costs.

The assumptions of the CVP model yield the following linear equations for total

costs and total revenue (sales):

5

Total cost = fixed cost +( unit variable cost x number of unit)

Total revenue = sales price x number of unit

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:

TC = TFC + V x X

TR = P x X

where

TC = Total costs

TFC = Total fixed costs

V = Unit variable cost (variable cost per unit)

X = Number of units

6

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.

These diagrams can be related by a rather busy diagram, which demonstrates how

if one subtracts variable costs, the sales and total costs lines shift down to become

the contribution and fixed costs lines. Note that the profit and loss for any given

number of unit sales is the same, and in particular the break-even point is the same,

whether one computes by

sales = total costs or as contribution = fixed costs.

7

CVP simplifies the computation of breakeven in break-even analysis, and more

generally allows simple computation of target income sales. It simplifies analysis

of short run trade-offs in operational decisions

Cost-volume-profit analysis is a managerial accounting technique used to analyze

how changes in cost and sales volume affect changes in a company's profit. The

technique is widely used in business and has many advantages. However, there are

some drawbacks as well. Understanding the pros and cons to CVP analysis can

help you determine whether this technique should be implemented in your

company.

ADVANTAGES AND DISADVANTAGE

Ease of Calculation

One the biggest advantages to CVP analysis is that calculations are

incredibly simple. CVP analysis uses a standard set of formulas that

8

work for all of the analysis techniques. Anyone who can plug

numbers into the formulas is able to quickly determine the effects of

hypothetical changes in these variables. This makes CVP analysis a

useful technique for small-business owners who are new to business

or do not have a strong accounting background.

Understandability

For the most part, CVP analysis is free of accounting jargon and

complex terminology. This makes both the preparation and

interpretation of CVP analysis figures understandable. For example,

you might want to know how many individual units of your

company's product you would need to sell to break even for the year.

In order to make this calculation, you will need to know how much it

costs to make your product and how the cost behaves -- that is,

whether the cost increases as production increases or whether it is a

constant. Unlike some accounting terminology, these cost concepts

are intuitive to many small-business owners.

9

Accuracy

One of the downfalls of CVP analysis is that it isn't always accurate.

CVP analysis techniques assume that all costs in the company are

completely fixed or completely variable. Fixed costs are costs that do

not change with changes in production, such as rent or insurance

costs. Variable costs change at a constant rate as you increase the

number of units produced. Common variable costs include materials

and labor costs. However, there are many costs that have a fixed and

variable component, known as mixed costs. For example, you may

pay a monthly charge for telephone service, but then pay a change

per minute of use. The monthly charge is a fixed cost, but the per-

minute charge is variable. CVP analysis does not have a way to deal

with these costs unless they are split into their fixed and variable

components, which can be cumbersome.

Inflexibility

10

As part of it being quick and easy to use, CVP analysis has a built-in

set of assumptions that are fairly rigid. For example, CVP analysis

assumes that a company sells one product, or that if it sells multiple

products the proportion of how much of each product is sold remains

constant. This is known as a constant sales mix assumption, and

many businesses do not follow this sales pattern. For example, a

restaurant probably sells more hot drinks in the winter than it does in

the summer, and these drinks could have different cost assumptions.

If your company has a large variety of products or if your mixture of

products sold changes frequently, then CVP analysis may not work

for you.

Approximations

Even though CVP analysis is based on specific data and requires

tremendous attention to detail, the best that it can do is provide

approximate answers to questions, rather than ones that are exact. It

answers hypothetical questions better than it provides actual answers

for solving problems. It leaves the business manager to decide how to

act on the CVP analysis data he has at hand. For this reason, the

manager has to exercise extreme caution when making decisions

11

about changes to business operations and finance. Judgments have to

be made after careful investigation and deliberation -- and not just be

based solely on statistics. Investigation may involve, for instance,

interviewing employees and carefully observing their daily activities,

as opposed to simply treating them as part of a statistical model.

Decision-Making

CVP analysis provides managers with the advantage of being able to

answer specific pragmatic questions needed in business analysis.

Questions such as what the company's breakeven point is help

managers project how future spending and production will contribute

to the success or failure of the company. For instance, when a

manager knows the breakeven point, he can tweak spending and

increase production efforts to increase profitability. Because CVP

analysis is based on statistical models, decisions can be broken down

into probabilities that help with the decision-making process.

Limitations

12

The CVP approach to analysis is beneficial, but it is limited in the amount of

information it can provide in a multi-product operation. Much of the analysis that

is done by business managers who use this approach is done based on a single

product. Northern Arizona University notes that multi-product businesses, such as

restaurants, can have a difficult time with CVP analysis because menu items, for

instance, are likely to have many variable cost ratios. This makes the challenge of

CVP analysis all the more difficult because it must be done for each specific

product.

Chapter 2

13

Brand History

Lay’s, the world’s largest and favourite snack food brand, has

steadily established itself as an indispensable part of India’s snacking

culture since its launch in 1995.

With its irresistible taste, international and Indian flavours and youth-

centric imagery, Lay’s has established itself as a youth brand and

continues to grow in the hearts and mind of its consumers.

Over the years, Lay’s has become known for its engaging and

innovative promotions and campaigns. The brand known for its ‘No

one can eat just one’ campaign has moved its positioning to ‘What’s

the programme?’ making Lay’s ‘the main food of every programme‘!

Saif Ali Khan has been the face of the brand for over five years, and

has recently been joined by the captain of the Indian cricket team

M.S. Dhoni. Both embody the youthful energy and appeal of the

brand.

14

In 2008, Lay’s launched the never-before ‘Fight for Your Flavour’

allowing consumers to vote for the flavour of their choice. The

flavour with the maximum votes would continue in the market. The

flavours have been selected by the Lay’s brand ambassadors Saif Ali

Khan and M.S. Dhoni with each celebrity rooting for the flavour of

their choice.

In November 2008, Lay’s made yet another innovative breakthrough

– the Chip-n-Sauce pack. This first-to-market pack has been launched

for cricket lovers as they settle in their seats to savour the best

sporting action of the season. The Lay’s Chip-n-Sauce large pack

comes in two unique flavours – Chilli Chinese with a Schezwan

Sauce sachet and Chatpata Indian with a Tamarind Sauce sachet

inside the pack.

In June 2009, Lay’s launched its new positioning platform: ‘Lay’s –

Be a Little Dillogical’. The new Dillogical concept makes an instant

connect with youth caught between the desire to succeed and the

15

desire to remain engaged with certain moments that offer a deep

emotional fulfilment. This friction is like a game between the heart

and the head, a struggle between what you want to do and what you

have to do. It’s all about making things that matter to the heart,

happen.

The new platform has been launched with a series of ads built around

the universal consumer struggle between what the mind asks one to

do and what the heart desires. A powerful 360 degree approach

supports the new TVC, and has indeed prompted consumers to be a

little Dillogical.

Brand Advantage

Lay’s is 100 percent vegetarian

Quality Standards

16

HACCP(Hazard Analysis and Critical Control Point).

Certification by TQCSI (Australia), which confirms that products are

manufactured in a food safety environment and the manufacturing

process has adequate controls to track products.

American Institute of Baking (USA), one of the best auditing bodies

for confirming process and product safety.

Our Plants are ISO 14000 certified , which confirms that the

manufacturing process ensures environmental safety.

Our plants are also certified to ensure that the safety of products,

processes, environment and people is maintained at a very high level.

This certification is issued by OHSAS 18001 (Occupational Health

and Safety Assessment Series), USA.

The production process begins on farms in select regions across India

where the best potatoes are grown specifically for Frito-Lay. Upon

the potatoes’ arrival at plants, it can take as little as 24 hours for the

chips to be made. Lay’s chips are made using the following simple

process:

Wash – the potatoes are thoroughly bathed in water.

17

Peel – next, we gently peel the skin off the potatoes, even as the

flavour remains intact.

Slice – The potatoes are thinly sliced and rinsed again to remove any

remaining starch.

Cook - The slices are cooked to a crispy crunch in edible vegetable

oils.

Season – Finally, the chips are topped off with a mouthwatering

sprinkle of salt or seasoning

The potatoes have now become delicious chips and are packed and

delivered to a store near you.

18