Cost –Volume- Profit Analysis
CVP analysis, sometimes termed break even analysis is an application of marginal costing and seeks to study the
relationship between costs, volume and profit at differing activity levels and can be a useful guide for short term
planning and decision making. It is a technique used to measure the effect on profit as a result of changes in volume of
activities, cost and prices. It also facilitates planning in the sense that CVP analysis could assist to predict future cost
levels and sales as related to a range of level of activity. It demonstrates how the profit will be affected as a result of
changes in any of the variables that make up the profit function. Its use requires the separation of the total cost function
into their variable and fixed portion, as required in the application of marginal costing principles.
The objectives of CVP analysis is to provide solution to the under-mentioned questions:
a) How many units must an organization produce and sell in order to be able to absorb the total cost of production or
what is the break-even point in units?
b) What is the total turnover required by an organization in order to equate the total cost of production or what is the
break-even point in sales value?
c) What will be the turn over required by an organization for the purpose of achieving a pre-determined level of profit.
d) Under a pre-determined amount of profit, how many units must an organization produce and sell in order to achieve
the desired profit target?
Basic Assumptions of C-V-P Analysis
a) All costs can be resolved into fixed and variable elements.
b) Semi-variable cost can be segregated into both the variable and its fixed components.
c) Selling price per unit is constant.
d) Variable cost per unit is constant.
e) Total fixed cost remain unchanged regardless of output.
f) Only one product is involved and in case of a multi-product organization, there is a constant sales mix.
g) The only factor affecting costs and revenues is volume
h) Over the activity range being considered costs and revenues behave in a linear fashion
i) Risk and uncertainty are non-existent
j) There is a relevant range.
Limitations of the basic assumptions
The basic assumptions of CVP have the following deficiencies:
a) It might be difficult to separate some costs into their fixed and variable cost portion.
b) The selling price per unit is assumed to be constant, this is not realistic because of possibility of discounts
c) Variable cost per unit is assumed to be constant. This is not realistic because quantity discount could result in
decrease in material cost and labour cost per unit could fall whenever the learning curve theory becomes applicable.
d) Fixed cost is assumed to remain unchanged. This is not true because in reality, fixed cost moves in a step like
manner.
e) It is assumed that production is equal to sale, hence no closing stock. This assumption looks unrealistic because a
business is a going concern and invariably stocks are carried from one period to the other.
Basic terminologies in C-V-P-A
a) Break-even: Break even explains a situation where a company is making neither profit nor loss. A
company that makes neither profit nor loss is said to be breaking even.
b) Contribution: this is the difference between sales revenue and variable cost or the addition of fixed cost and
profit.
c) Contribution margin ratio (CMR): This is also known as contribution to sales ratio (C/S ratio) or Profit
volume ratio. It is designed to measure the level of contribution derivable from a specified amount.
d) Margin of Safety: This indicates the extent to which sales may decrease before loss begin to set in.
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Formulas involved in CVP Analysis
a) Break-even point (in units) = Fixed costs
Contribution/unit
b) C/s ratio = Contribution/unit x 100
Sales price per unit
c) C/s ratio when selling price or sales value is omitted = FC + Profit
Contribution + Variable cost
d) C/s ratio when net profit is presented at different levels of activity = change in profit
Change in sales value
e) Break-even point (N Sales)= Fixed cost OR Break even point in unit x Selling price.
C.M.R
f) Level of sales to result in target profit (in units) = Fixed costs + Target profits
Contribution/unit
Note: The target profit is always profit before tax and not profit after tax. However if profit after tax is given the
following formula should be used to convert it to profit before tax.
Profit before tax = Profit after tax
1 - tax rate
g) Level of sales to result in target profit (N sales) = (Fixed cost + Profit) x Sales price/unit
Contribution/unit
h) Margin of safety in unit = Budgeted/Actual sales unit – B.E.P in unit.
i) Margin of safety in sales value = Budgeted/Actual sales value - B.E.P in sales value.
j) Margin of safety in percentage= expected/ Actual sales – B.E.P sales
Expected/Actual sales
Note that C/s + V/s = 1. Where V/S is variable cost to sales.
C-V-P-A in a multi- product firm
A firm is said to be a multi-product firm if it produces more than a product. In this situation, the B.E.P of a particular
product line will not represent the B.E.P of the entire organization. This is due to the fact that individual product is
expected to operate under different cost structure, marketing strategy and also different market all together.
Steps involved in ascertaining B.E.P in a multi- product firm
1) Identify the total fixed cost of the entire organization irrespective of the number of product lines.
2) Compute the contribution margin ratio for the entire organization using either the total value method or the
weighted average method.
3) Use the information obtained in one and two above to determine the break even in sales value for the entire
organization irrespective of the number of product.
4) Determine the individual sales proportion as a percentage of the total sales value
5) Apply the individual product sales percentage obtained above to the total B.E.P in sales value obtained in (3) above.
6) In order to identify the individual product B.E.P in unit, divide the individual product B.E.P in sales value by their
corresponding selling prices.
Break even Chart
This is another way of presenting management with information about the effect on revenue and profit at different levels
of activity. It is an elementary form of profit volume graph.
Steps involved in construction of breakeven chart
1) Select a scale for sales on x axis
2) Select a scale for cost and revenue on y axis.
3) Draw the fixed cost line parallel to the x axis.
4) Draw the variable cost line starting from y axis where you have the fixed cost to give total cost.
5) Draw the sales line starting from the point of origin (0) to end at maximum sales.
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Profit Volume graph
This is a development of the break even chart and portrays the relationship of profit to volume or output. It uses the
same basic data as break even chart.
Steps involved in the construction of profit volume graph
a) Select a scale for sales on x axis.
b) Select a scale for fixed cost and profit on y axis
c) Divide the graph into two (2) areas, ne representing profit and the other representing loss.
d) On y axis, the area above the sales line represents profit and the area below the sales line represents fixed cost.
e) Plot the required points for fixed cost and profit and draw a line to connect both of them.
QUESTIONS
Question 1
The data below relates to a particular manufacturing company:
Year Total sales (N) Total cost (N)
1 39,000 34,800
2 43,000 37,600
Required, determine:
a) Total fixed cost.
b) Profit volume ratio
c) Break-even point.
d) The margin of safety for year 1 and 2.
Question 2
Chin chun Limited manufactured a single product with a sales of N500,000 per unit. The following also relate to the
organization:
Raw materials 20kg @ N5,000/kg N100,000
Direct labour 2 hours @ N75,000 per hour N150,000
Variable overheads 2 hours @ N25,000 per hour N50,000
Fixed costs are N30,000,000 per annum. You are required to:
a) Calculate the number of units to sell in order to break even.
b) Sales at B.E.P
c) C/s ratio
d) Number of units to be sold to achieve a profit of N40,000,000.
Question 3
ABC Ltd manufactures one product only which it sells at N20 per unit. Existing plant have a maximum capacity of
20,000 units at which level net profit is N1.50 per unit and the profit volume ratio is 20%. New plant is to be purchased
having a maximum capacity of 30,000 units per annum but which will result in fixed cost being increased by N15,000
per annum.
The variable cost will be reduced by N4 per unit and to achieve increased sales, the selling price is to be reduced by
N4/unit. You are required to:
a) Explain what you understand by the terms profit volume ratio and margin of safety.
b) Calculate the revised PV ratio as a result of the purchase of new plant.
c) Calculate the number of units which will be required to be produced using new plant to give a 50% increase in
profit compared with maximum production using old plants
d) Calculate the margin of safety if the actual level of sales is 25,000 units assuming the new plant is purchased.
Question 4
Ayomide Ltd makes a single product with a sales price per unit of N10 and a marginal cost per unit of N6, fixed costs
are N60,000. Calculate.
a) Number of units to break-even.
b) Contribution ratio
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c) Sales in Naira at break-even point.
d) What number of units will need to be sold to achieve a profit of N20,000 per annum.
e) As (d) above but, assuming the profit is PAT and the tax rate is 40%.
Question 5
Me and You company makes a single product with a sales price per unit of N20 and a marginal cost per unit of N12
while fixed cost total up to N120,000 per annum.
You are required to calculate the following:
a) Number of units to break-even.
b) Sales in Naira at break-even point.
c) Contribution to sales ratio
d) What number of units will need to be sold to achieve a profit of N40,000 per annum?
e) What level of sales will achieve a profit of N40,000 per annum.
f) If the tax rate is 40% how many units will need to be sold to make a profit after tax of N40,000 per annum.
g) Because of increasing costs, the marginal cost is expected to rise to N13 per unit and fixed costs to N140,000 per
annum. If the selling price cannot be increased what will be the number of units required to maintain a profit of
N40,000 per annum? (ignore tax)
Question 6
Infinite supplies Nig Ltd tentative budget for product OLIVA for 2012 is as follows:
N N
Sales (2,500 units @ N40/unit) 100,000
Manufacturing cost of goods sold:
Direct labour 15,000
Direct materials 14,000
Variable factory overhead 10,000
Fixed factory overhead 5,000 44,000
Gross Profit 56,000
Selling Expenses:
Variable 6,000
Fixed 10,000
Administrative expenses:
Variable 5,000
Fixed 10,000 31,000
Operating income 25,000
Required:
a) How many units of product OLIVA would have to be sold to break-even?
b) What would be the operating income if projected sales increased by 30%.
Question 7
Draw a break-even chart from the following figures.
Sales Profit
N N
Year 1 6,400,000 160,000
Year 2 7,000,000 400,000
Predict the variable cost, contribution, fixed cost and profit associated with N10 sales volume and set your prediction in
the form of a profit statement.
Question 8
In a firm, a detailed budget of costs and sales at various levels had been prepared but due to the computer operator’s
negligence, most of the information was destroyed.
The following are the data that could be rescued:
Sales level (unit) 6,000 8,000
N N
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Material cost 18,000 24,000
Labour cost 15,000 19,000
Overhead cost 11,700 14,700
The selling price is N8.00 per unit at all levels.
You are required to compute:
a) The fixed element, if any, of each component cost.
b) The breakeven point in units and values.
Question 9
You are required to prepare to the board of directors of ALI Ltd a break even chart based on the following information
Activity level (unit) 5,000 10,000 15,000 20,000
Fixed cost N60,000 N60,000 N60,000 N60,000
Selling price is N10 each and variable cost is N5 per unit.
Required:
a) Determine the breakeven point in unit and sales value.
b) Margin of safety in unit and naira value.
Question 10
Oyo Limited had the following results in the year 2012
N
Sales 200,000
Total variable cost 120,000
Fixed cost 50,000
Profit 30,000
Required:
Draw the profit volume graph using the above data.
Question 11
A company manufactures and sells two products x and y. the forecast data for a year are:
Product x product y
Sales (units) 80,000 20,000
Sales price per unit N12 N8
Variable cost per unit N8 N3
Annual fixed costs are estimated at N273,000. What is the break even point in sales value with the current sales mix.
Question 12
Indomie Ltd manufactures and sells two products A and B, annual sales are expected to be in the ratio 1:3. Total annual
sales are planned to be N420,000, product A has a contribution to sales ratio of 40%, whereas that of product B is 50%.
Annual fixed costs are estimated to be N120,000.
Find the budgeted break even sales value (to the nearest N1000)
Illustration 13
For the forth coming year, the management accountant of Action Times Ltd has projected that sales and contributions
will have the following patterns:
Products Sales Selling price Contribution CMR
N N N
A 180,000 18 54,000 0.3
B 42,000 21 (4,200) -0.1
C 90,000 45 - -
D 168,000 42 67,200 0.4
E 120,000 30 60,000 0.5
Required: determine the number of units of each product to be sold in order to earn a profit after tax of N116,400
assuming the total fixed cost is N120,000 and tax rate is 20%.
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Question 14
Coca-Cola Ltd manufactures and sells four types of products under the brand names Ace, Utility, Luxury and
supreme. The sales mix in value comprises:
Brand Percentage
Ace 33 1/3
Utility 41 2/3
Luxury 16 2/3
Supreme 8 1/3
100
The total budgeted sales (100%) are N600,000 per month.
The variable costs are:
Ace 60% of selling price
Utility 68% of selling price
Luxury 80% of selling price
Supreme 40% of selling price
a. The fixed costs are N159,000 per month. Calculate the break-even point for the products on an overall
basis.
b. It is proposed to change the sales mix as follows with the total sales per month remaining at N600,000
Brand Percentage
Ace 25
Utility 40
Luxury 30
Supreme 5
Assuming that this proposal is implemented, calculate the new break-even point.
Question 15
Ariyo Ltd produces an electric multi-purpose tol which sells for N10.50k. sales amounting to N4.2 million
represents 80% capacity of the factory and this is regarded as the normal level of activity with costs as
follows:
Prime cost per unit N4.50k
Factory indirect costs N220,000 (including variable cost of N60,000)
Selling costs N170,000 (including variable cost of N80,000)
Distribution costs N100,000 (including variable cost of N60,000)
Administration costs N720,000
Local promotional commission payable averages 7.5% of sales value.
You are required to:
(a) Calculate the break-even level
(b) Prepare statements showing sales income, costs and profit:
(i) At the normal level of activity
(ii) If unit selling price is reduced by 5% thereby increasing sales volume by 12.5% of the normal
activity level
(iii) If unit selling price is reduced by 10% thereby increasing sales volume by 25% of the normal
activity level.
(c) Calculate the contribution margin ratio at the three levels of the activity referred to in (b) above
(d) Calculate the quantity to be sold under the price arrangements referred to in b(iii) in order that the profit
may be the same as in b(ii).
