FINANCIAL
MANAGEMENT
CVP ANALYSIS AND LEVERAGE
ANALYSIS
Ms.Gayatri Mohanty
Presented by:- Vinay Dahiya
Pankaj Bhardwaj
Deepak Sharma
Arpit Mittal
COST VOLUME PROFIT
Examines the behavior of total revenues, total costs, and operating income as
changes occur in the output level, selling price, variable costs or fixed costs.
CVP analysis is a managerial tool showing the relationship between various
ingredients of profit planning, cost (FC & VC), selling price, and volume of activity.
CVP analysis is an important tool of profit planning. It provides information about
following matters:-
1.Behaviour of cost in relation to volume.
2.Volume of production or sales, where business will break even.
3.Sensitivity of profit due to variations in output.
4.Amount of profit for projected sales volume.
5.Quantity of production & sales for target profit level.
IMPORTANCE
It helps in forecasting profit fairly accurately.
It is helpful in setting up flexible budgets, since on the basis of this relationship,
it can ascertain the cost, sales and profits at different levels of activity.
It also assists us in performance evaluation for purposes of management control.
It helps in formulating price policy by projecting the effect which different cost
structures will have on cost and profits.
It help in determining amount of overhead cost to be charged at various levels of
operations, since overhead rates are generally predetermined on the basis of
selected volume of production.
CVP ASSUMPTIONS
1. Revenues change in relation to production and sales
2. Costs can be divided in variable and fixed categories.
3. Revenues and costs behave in a linear fashion.
4. costs and prices are known.
5. if more than one product exists, the sales mix is constant.
6. we can ignore the time value of money.
CVP FORMULA
•
Profit/volume ratio (P/V Ratio):- it establishes a relationship
between the contribution and sales value
BREAK EVEN POINT
• The
point which breaks total cost and selling price evenly to show
level of output or sales at which there shall neither profit nor loss,
is regarded as break-even point. The income of business exactly
equals its expenditure.
BEP(Unit)
BEP(OUTPUT)
Cost-Volume-Profit Graph
Breakeven Total revenues
10,000 line
Point
8,000 Total costs
line
6,000
Operating
4,000 income
2,000
Operating
0 loss
0 10 20 30 40 50
Units Sold
Leverage
LEVERAGE
•
• The dictionary meaning of the firm leverages refers to “an increase means of
accomplishing purpose ”.In machines , leverages means the instrument that
helps us in lifting heavy objects, which may not be other wise possible. This
concept of leverage is valid in business too. In financial management , it is used
to describe the firms ability to use fixed assets costs funds to satisfy to magnify
to return of its owners.
• “Leverage is the ratio of the net rate of return on shareholder’s equity and net
rate of return on total capitalization.”
Leverage
SALES EBIT
SALES REVENUE
REVENUE EBIT
Minus(-) Minus(-)
Minus(-) INTEREST
Minus(-) VARIABLE
VARIABLE INTEREST
COST =PROFIT
=PROFIT BEFORE
BEFORE
COST
= TAX
= CONTRIBUTION
CONTRIBUTION TAX
Minus(-) Minus(-)
Minus(-) TAX
Minus(-) FIXED
FIXED COST
COST TAX
=EBIT =PROFIT AFTER
=PROFIT AFTER
=EBIT
TAX
TAX
TYPES OF LEVERAGE
FINANCIAL LEVERAGE
OPERATING LEVERAGE
COMBINED LEVERAGE
FINANCIAL LEVERAGE
•
Financial leverage:- A firm needs funds so run and manage its activities. The funds are
first needs to set up an enterprise and then to implement expansion , diversification and
other plans . A decision has to be made regarding the composition of funds. The funds
may be raised through two sources., owners, called owners equity , and outsiders, called
creditors equity.
Financial leverage exists whenever a firm has debts other sources of funds that carry
fixed charges. ”
Financial Leverage
Earning Per Share
Degree of financial Leverage
OPERATING LEVERAGE
• Operating
leverage This leverage is associated with the employment of fixed cost assets.
It is calculated to know income of the company on different levels of sales. It is measure
of effect on operating profit of the concern on change in sales.
According to Solomon Ezra :According to Solomon Ezra “operating leverage is the
tendency of the operating profit to vary disproportionately with sales.
Degree of operating leverage
COMBINED LEVERAGE
• Composite leverage Composite leverage is calculated to determine the combined
effect of operating and financial leverages.
Combined leverage = OL * FL
Combined leverage *
Degree of combined Leverage = DOL * DFL
