COST VOLUME PROFIT
ANALYSIS
4 PICS / 1 WORD
C O S T
VO L UME
COST VOLUME
PROFIT ANALYSIS
ASSUMPTIONS IN CVP ANALYSIS
- costs are classified as variable or fixed
- variable costs change at a linear rate
- fixed costs remains unchanged within the relevant range
- selling prices do not change as sales volume changes
- for multiple product companies, sales mix usually remains constant.
- Inventory levels remain constant and is not focused too much in CVP
analysis
- Volume is the greatest factor affecting costs
BASIC BREAK EVEN ANALYSIS
A breakeven analysis determines the sales volume your business
needs to start making a profit, based on your fixed costs, variable
costs, and selling price.
Break even point
- the point wherein the entity does not enjoy a profit but does not incur a
loss, which is when total contribution margin equals total fixed costs.
- this is a determinant on how much sales or how much units to be sold to be
able to, at least, cover all operational costs.
Formula:
Breakeven point (units) =
Total Fixed cost
Sales price-Variable cost/ unit
Breakeven point (units) =
Total Fixed cost
Contribution Margin per unit
*Contribution Margin per unit = Sales price-Variable cost/ unit
Example:
Sam’s Sodas is a soft drink manufacturer in the urban area. He is
considering introducing a new soft drink, called Sam’s Silly Soda. He
wants to know what kind of impact this new drink will have on the
company’s finances. So, he decides to calculate the break-even
point, so that he and his management team can determine whether
this new product will be worth the investment.
Accounting costs are as follows, for the first month the product will be
in production:
Fixed Costs = 20,000 (total, for the month)
Variable Costs = 40 (per can produced)
Sales Price = 150 (a can)
Solution:
Breakeven point (units) =
Total Fixed cost
Sales price-Variable cost/ unit
MULTIPLE PRODUCT BREAK EVEN
ANALYSIS
Multi-product break-even analysis is used when the business
produces more than one product, and all products contribute to the
overall revenue of the business in defined proportions.
Formula:
Example:
The company manufactures and sells three products, A, B and
C. The following information is given:
The company sells 5 units of C for every unit of A and 2 units
of B for every unit of A. Hence, the sales mix is 1:2:5. The
company incurred in $120,000 total fixed costs.
Solution:
Breakeven point in units = Total Fixed cost
Weighted Average CM per unit
=
$120,000
$18.75
=
6,400 UNITS
Solution:
Computation of weighted average CM per unit:
Breakdown of the break even sales in units:
MARGIN OF SAFETY
-
-
Is the difference between actual sales and
break even sales
It indicates the maximum amount by which
sales could decline without incurring a loss
FORMULA
Margin of Safety = Actual or Planned Sales – Break even Sales
Margin of Safety Ratio = Actual or Planned Sales – Break even Sales
Actual or planned sales = Margin of Safety Actual or Planned Sales
EXAMPLE
Assume that Fermay Company has budgeted sales of 5000 units or P50 0
00 for the next period. Considering that the Company’s break-even sales is
2 000 units or P20 000, the margin of safety can be calculated as follows:
Margin of Safety in PESOS = Planned Sales – Break even Sales
= P50 000 – P20 000
= P30 000
Margin of Safety in UNITS = 5 000 units – 2 000 units
= 3 000 units
Margin of Safety Ratio
= Margin of Safety = P30 000 or 3 000 units
Planned Sales = P50 000 or 5 000 units
= 0.60 or 60%
DEGREE OF OPERATING LEVERAGE (DOL)
- Measures how a percentage change in sales will
affect company profits.
- Also known as operating leverage factor.
FORMULA:
Degree of Operating Leverage = Contribution Margin
Profit before tax
EXAMPLE:
Following is the company’s result of operations from its present sales level
of 10 000 units:
Sales (10 000 units @5)
Variable costs (10 000 units @ P3)
Contribution Margin
Fixed Costs
Profit before Tax
P50 000
30 000
20 000
12 000
8 000
REQUIREMENTS:
1. Determine the degree of operating leverage.
2. If the company’s sales would increase by 10% its profit before tax would
increase by how many percent?
SOLUTION
1. Determine the degree of operating leverage.
Degree of Operating Leverage = Contribution Margin ÷ Profit before tax
= P20 000 ÷ P8 000
= 2.5
2. If the company’s sales would increase by 10% its profit before tax
would increase by how many percent?
% change in sales x degree of operating leverage = % change in Profit
before Tax
10% x 2.5 = 25%
PRESENT PROPOSED CHANGE
Sales (10 000 units @5)
P50 000 P 55 000
10%
Variable costs (10 000 units @ P3)
30 000
33 000
Contribution Margin
20 000
22 000
Fixed Costs
12 000
12 000
Profit before Tax
8 000
10 000
Percentage change in profit = P10 000 ÷ 8 000 = 2 000
= 2 000 ÷ 8 000 = 25%
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