E2Cost volume profit Analysis
CVP ANALYSIS - is a profit planning tool that deals with profit’s relationship with costs and sales
volume.
Traditional Income Statement
Sales
Less: Cost of goods sold
Gross Margin/Profit
Less: Operating expenses
Operating Profit (pre Tax profit)
Tax Rate
After tax profit
PXX
XX
PXX
XX
PXX
XX%
PXX
100%
(XX%)
(XX%)
Contribution Income Statement
Sales (Sales Volume X Selling Price)
Less: Variable cost (Sales Volume X VC per unit)
Contribution Margin (Sales Volume X CM per unit)
Less: Fixed Cost
Operating Profit (pre Tax profit)
Tax Rate
After tax profit
Total Percentage
PXX
100%
XX
(XX%)
PXX
(XX%)
XX
PXX
XX%
PXX
*Traditional Income Statement is used primarily for external reporting while Contribution Income
Statement is used primarily by management.
Usage of CVP Analysis in Managerial Decisions
 Product pricing
 Accepting/rejecting sales orders
 What product lines to promote?
 What level of output is required to achieve a set level of net profit?
 Feasibility of profit plan
 Technology usage
CONTRIBUTION MARGIN (CM) is a measure of company’s ability to cover variable costs with
revenues. It is also known as marginal income, profit contribution, contribution to fixed cost or
incremental contribution.
CM = Sales – Variable Costs
Unit CM = Unit Selling Price – Unit Variable Costs
CM Ratio = CM ÷ Sales = Unit CM ÷ Unit Selling Price = Δ CM ÷ Δ Sales
CM Ratio is also known as marginal ratio or profit-volume (P/V) ratio.
BREAK-EVEN POINT (BEP) is the sales level at which profit is zero (i.e., total revenues = total costs).
BEP(units) = Fixed Costs ÷ Unit CM
BEP (peso sales) = Fixed Costs ÷ CM Ratio
BEP Ratio = BEP ÷ Sales
Sales (units) with Target Profit = (Fixed Costs + Target Profit*) ÷ Unit CM
Sales (peso sales) with Target Profit = (Fixed Costs + Target Profit*) ÷ CM Ratio
Sales (peso sales) with Target Profit Ratio = Fixed Costs ÷ (CM Ratio – Profit Ratio)
* Target Profit must be expressed before tax: Pre-tax Profit = After-tax Profit ÷ (100% - tax rate)
MARGIN of SAFETY is the maximum amount by which sales could decrease without incurring a loss.
Margin of Safety (MS) = Sales – Breakeven Sales = Profit ÷ CM Ratio
MS Ratio = MS ÷ Sales = Profit Ratio ÷ CM Ratio = 100% - BEP Ratio
Like BEP, safety margin can also be expressed in units or in peso sales.
INDIFFERENCE POINT is the level of volume at which total costs, and hence profits, are the same
between two alternatives under consideration.
Alternative A
Alternative B .
(Unit CM x Q) – Fixed Costs = (Unit CM x Q) – Fixed Costs
Fixed Costs + (Unit VC x Q) = Fixed Costs + (Unit VC x Q)
Legend: Q – number of units (indifference point)
SALES MIX (a.k.a. product mix) is the proportion of different products that comprise the company’s
total sales.
Overall BEP (units) = Fixed Costs ÷ Weighted Average Unit CM
Overall BEP (peso sales) = Fixed Costs ÷ Weighted Average CM Ratio
DEGREE of OPERATING LEVERAGE (DOL) measures how sensitive the profit is to sales volume
increases and decreases. It is also known as operating leverage factor.
DOL = Contribution Margin ÷ Profit before tax = 1 ÷ MS Ratio
Δ% in Sales x DOL = Δ% in profit before tax
CVP analysis assumptions and limitations
 Behavior of both sales and costs (variable and fixed) is linear and predictable throughout the
entire relevant range of activity and within a specified time span.
 Fixed costs, unit variable costs, selling price and sales mix must behave as constants.
 There are no changes in inventory levels (i.e., production equals sales).
 Volume is the only factor affecting sales, variable costs and profit.
 Time value of money is ignored.
Margin of Safety
1. Dani Company has sales of P 100,000, fixed costs of P 50,000, and a profit of P 10,000. What is Dani
Company’s margin of safety?
a. P 10,000
b. P 16,667
c. P 33,333
d. P 83,333
2. Viconia Company had a 25 percent margin of safety. Its after-tax return on sales is 6 percent. The
company’s income is subject to tax rate of 40 percent. If fixed costs amount to P320,000, how much
peso sales did Viconia make for the year?
A. P1,066,667 C. P1,280,000
B. P1,000,000 D. P 800,000
3. Romero, Inc. had the following economic data for 2021:
Net sales
Contribution margin
Margin of safety
P400,000
160,000
40,000
What is Romero’s breakeven point in 2021?
A. P360,000
C. P320,000
B. P288,000
D. P 80,000
4. The following information pertains to Joshua Corporation for the year ending December 31, 2021:
Budgeted sales P1,000,000
Breakeven sales 700,000
Budgeted contribution margin 600,000
Cashflow breakeven 200,000
The margin of safety for the Joshua Corporation is:
A.
B.
C.
D.
P300,000
P400,000
P500,000
P800,000
Indifference point
5. Machine XX has fixed costs of P 225,000 and a variable cost of P 20. Machine YY has fixed costs of
P 300,000 and a variable cost of P 14. What is the indifference point in units?
a. 11,250
b. 12,500
c. 21,429
d. Cannot be determined from given information
6. Duke, Inc. owns and operates a chain of food centers. The management is considering installing
machines that will make popcorn on the premises. These machines are available in two different sizes
with the following details:
Annual capacity
Costs: Annual machine rental
Popcorn cost per box
Cost of each box
Other variable cost per box
Economy
Regular
20,000
P60,000.00
3.90
0.80
6.60
50,000
P82,500.00
3.90
0.80
4.20
The level of output in boxes at which the Economy and the Regular would earn the same profit (loss) is
a.
b.
c.
d.
20,000 boxes
9,375 boxes
15,000 boxes
12,500 boxes
7. Mellow, Inc. sells its single product for P40 per unit. Mellow purchases the product for P20. The
salespeople receive a salary plus a commission of 5% of sales. Last year the corporation’s net income
was P100,800. The corporation is subject to 30% income tax rate. The fixed costs of the company are:
Advertising
Rent
Salaries
Other fixed costs
Total
P124,000
60,000
180,000
32,000
P396,000
The company is considering changing the compensation plan for sales personnel. If the organization
increases the commission to 10% of revenues and reduces salaries by P80,000, what revenues must the
organization have to raise in order to earn the same net income as last year?
a.
b.
c.
d.
P1,600,000
P1,350,000
P1,150,000
P1,630,000
Solution:
1. B
Sales
Variable Cost
Contribution Margin
Fixed Cost
Profit
P100,000 100%
40,000 40%
60,000 60%
50,000
P 10,000
Margin of Safety = Profit/CM ratio = P10,000/60% = P16,667
Or
MOS = Sales – BEP (Peso Sales) = P100,000 – P83,333 = P16,667
(BEP = P50,000/60% = P83,333)
2. A
Margin of safety ratio = Profit ratio/CM Ratio
CMR = Before-tax return on sales/MSR = (0.06 ÷ 0.60) ÷ 0.25 = 0.40 or 40%
BES = 320,000 ÷ 0.40 = P 800,000
Sales = P800,000/.75 = P1,066,667
3. A
BEP = Sales – Margin of Safety = P400,000 – P40,000 = P360,000
4. A
MOS = Sales – Breakeven Sales = P1,000,000 – P700,000 = P300,000
5. B
XX
FC + (VC X Q)
P225,000 + P20X
P20X – P14X
P6X = P75,000
X = 12500 units
=
=
=
YY
FC + (VC X Q)
P300,000 + P14X
P300,000 – P 225,000
6. B
Economy
Regular
P60,000 + (P11.30X) = P82,500 + (P8.9X)
P11.30X – P8.9X = P82,500 – P60,000
P2.4X = P22,500
X = 9,375
7. A
Indifference Point = Decrease in Fixed Cost/Increase in Variable Cost
=P80,000/.05
=P1,600,000