Introduction:- this Study Guide applies cost-volume-profit (CVP) analysis to single product
situations & explains:
1) Break-even point & margin of safety
2) Target profit or revenue & a contribution to sales ratio and how to use these concepts
3) Elements in traditional & contribution break-even charts & profit / volume charts
Cost-volume-profit (CVP) analysis
Analysis of effects on future profit of y-axis = Revenue, costs & profit (loss)
changes in fixed cost, variable cost,
sales price, quantity & mix x-axis = Production & sales
Assumptions CVP analysis:
Selling price per unit is constant
Costs can be categorised into fixed &
variable elements
Semi-variable costs can be split into
fixed & variable elements
Fixed costs remain constant &
variable costs vary proportionately
Costs & revenues behave in a linear
fashion
Inventory is valued at marginal cost
Production / sales volume can only
affect costs & revenues
Cost-Volume-Profit (CVP) Analysis F1.1
Short-Term Decision Making Techniques F1.2
Understand & use, the concepts of a target profit or revenue & a contribution to
sales ratio
Marginal cost equation
Profit
- = Contribution - Fixed cost =
Sales
Variable
Target revenue determined
keeping in mind the target profit
Target profit Profit business expects to earn
under given conditions
(Fixed cost + Target profit)
Target sales volume =
Contribution per unit
Target revenue = Target sales volume x Expected selling price
Reconcile budgeted profit or contribution with actual profit or contribution under
standard marginal costing
Contribution to sales (C/S) ratio
High C/S ratio
C/S ratio or profit volume
ratio (P/V ratio)
Expressed Remains constant A measure Indicates Signifies that
as a if selling price & of high contribution grows
percentage variable cost profitability profitability more quickly compared
remain constant to in sales level
Total contribution
Contribution to sales ratio = x 100
Sales value
(Sales – Variable costs)
= x 100
Sales value
Usage of C/S ratio:
To determine break-even point in monetary terms
Break-even point indicates business is neither in loss nor in profit
Calculated separately for each product or sales area to determine most profitable business line / product
Cost-Volume-Profit (CVP) Analysis F1.3
Short-Term Decision Making Techniques F1.4
Interpret a break-even point (BEP) & a margin of safety (MOS)
Break-even point Contribution = Fixed cost
Total fixed costs
Break-even point sales in units =
Contribution per unit
Break-even point in terms of sales value = Fixed costs C/S ratio or
Break-even point in units x Selling price per unit
Margin of safety (MOS) Margin of safety %
= Budgeted / Expected sales – Sales at = {(Budgeted / Expected sales – Sales at
break-even point break-even point)/Sales} x 100
MOS BEP is much below the
signifies
sales level
MOS High fixed costs and a high
signifies C/S ratio
Elements in traditional & contribution break-even charts & profit/volume charts
Contribution break-even chart Profit/volume chart
Vertical axis indicates profits & losses &
horizontal axis is drawn at zero profit or loss
Single line drawn depicting profit or loss at
each level of activity
Point of intersection of line & horizontal axis
is break-even point
Variable cost line instead of fixed cost line as is
shown in a traditional break-even chart
This is done in order to overcome major problem
with traditional break-even chart; that it is not
possible to read contribution directly from chart
Contribution can be read as difference between
sales revenue line & variable cost line
Note- Traditional break-even chart page no. F1.1
Cost-Volume-Profit (CVP) Analysis F1.5
Short-Term Decision Making Techniques F1.6
