MAS 1: Cost-Volume-Profit Analysis | Lester M.

Camaso

COST-VOLUME-PROFIT (CVP) ANALYSIS

Also called Breakeven Analysis, CVP analysis is a means of understanding the interaction of revenues
with fixed and variable costs.

The breakeven point is the output at which total revenues equal total expenses.

Assumptions of CVP

a. Cost and revenue relationships are predictable and linear. These relationships are true over the
relevant range of activity and specified time span.
b. Unit selling prices do not change.
c. Inventory levels do not change, i.e., production equals sales.
d. Total variable costs change proportionally with volume, but unit variable costs do not change.
e. Fixed costs are constant over the relevant range of volume, but unit fixed costs vary indirectly
with volume.
f. The revenue (sales) mix does not change.
g. The time value of money is ignored.

CVP Chart
 MAS 1: Cost-Volume-Profit Analysis | Lester M. Camaso

Breakeven Point for a Single Product

The simplest calculation for breakeven in units is to divide fixed costs by the unit contribution margin
(UCM).

The breakeven point in peso sales equals fixed costs divided by the contribution margin ratio (CMR).

Figure 1

Whiterun is a manufacturer of white chocolates. One of its product has a unit sales price of P6.00 and a
variable cost of P2.00. Fixed Costs are P100,000.

Unit selling price ₱ 6.00

Minus: Unit variable costs 2.00
Unit contribution margin (UCM) ₱ 4.00

Breakeven point in units = Fixed costs ÷ UCM

= ₱ 100,000 ÷ ₱4.00
= 25,000 units
Whiterun's contribution margin ration is 66.67% (₱4.00 ÷ ₱6.00).

Breakeven point in peso = Fixed costs ÷ UCM

= ₱ 100,000 ÷ 66.67%
= ₱ 150,000

Margin of Safety

Margin of Safety is the excess of budgeted sales over breakeven sales, i.e., the amount by which sales
can decline before losses occur.

Margin of Safety Ratio is the percentage by which sales exceed the breakeven point.
 MAS 1: Cost-Volume-Profit Analysis | Lester M. Camaso

Figure 2

In units In peso:
Margin of safety Margin of safety
= Planned sales - Breakeven sales = Planned sales - Breakeven sales
= 35,000 - 25,000 = (35,000 units x ₱6.00) - ₱150,000
= 10,000 units = ₱210,000 - ₱150,000
= ₱60,000

Margin of safety ratio = Margin of safety Margin of safety ratio = Margin of safety
Planned sales Planned sales
= 10,000 units = ₱ 60,000
35,000 units ₱ 210,000
= 28.57% = 28.57%

Target Operating Income

An amount of operating income, either in dollars or as a percentage of sales, is frequently required. By

treating target income as an additional fixed cost, CVP analysis can be applied.

Figure 3

Whiterun with ₱4.00 contribution margin per unit wants to determine how many units of white chocolate
must be sold to generate ₱250,000 of operating income.

Target unit (Fixed costs + Target operating income) ÷

volume = UCM
= (₱100,000 + ₱250,000) ÷ ₱4.00
= ₱350,000 ÷ ₱4.00
= 87,500 units
Target Net Income

A variation of this problem asks for net income (an after-tax amount) instead of operating income (a
pretax amount).
 MAS 1: Cost-Volume-Profit Analysis | Lester M. Camaso

Figure 4

Whiterun wants to generate ₱245,000 of net income. The effective tax is 30%.

Target unit volume {Fixed costs + [Target net income ÷ (1.0-0.3)] ÷

= UCM
= [₱100,000 + (₱245,000 ÷ 0.70)] ÷ ₱4.00
= ₱450,000 ÷ ₱4.00
= 112,500 units

Other Target Income Applications

Analyses of other target income applications use the standard formula for operating income.

Figure 5

If units are sold at ₱6.00 and variable costs are ₱2.00, how many units must be sold to realize operating
income of 15% of sales, given fixed costs of ₱37,500?

Let X be the number of units to be sold

Operating income = Sales - Variable costs - Fixed costs
15%(₱6X) = (₱6X - ₱2X) - ₱37,500
₱0.9X = ₱4X - ₱37,500
₱3.1X = ₱37,500
X = 12,097 units

Operating Leverage

Operating leverage measures how a given percentage change in sales affects net operating income.
Degree of Contribution margin
=
operating leverage Net operating income

% Increase in Net Operating Income = % Increase in Sales x Operating Leverage

Figure 6
Dark Chocolate White Chocolate
Sales ........................................................... ₱500,000 100% ₱500,000 100%
Variable expenses ...................................... 350,000 70% 100,000 20%
Contribution margin................................... 150,000 30% 400,000 80%
Fixed expenses ........................................... 90,000 340,000
Net operating income ................................ ₱ 60,000 ₱ 60,000
Degree of operating leverage .................... 2.5 6.7
 MAS 1: Cost-Volume-Profit Analysis | Lester M. Camaso

If the degree of operating leverage is 2.5, then a 10% increase in sales should result in a 25% (= 2.5 × 10%)
increase in net operating income.

The degree of operating leverage is not constant—it changes with the level of sales.

At the higher level of sales, the degree of operating leverage for Dark Chocolate decreases from 2.5 to 2.2
and for Company Y from 6.7 to 4.4.

Figure 7

Dark Chocolate White Chocolate

(000s) (000s)
Sales ................................................................ ₱500 ₱550 ₱500 ₱550
Variable expenses ........................................... 350 385 100 110
Contribution margin ....................................... 150 165 400 440
Fixed expenses................................................ 90 90 340 340
Net operating income ..................................... ₱ 60 ₱ 75 ₱ 60 ₱100
Degree of operating leverage ......................... 2.5 2.2 6.7 4.4

Ordinarily, the degree of operating leverage declines as sales increase.

Multi-Product Break-Even Analysis

The relative proportions in which the products are sold is called the sales mix. If the sales mix changes,
the overall contribution margin ratio will change.
Example: Assume that total sales remain unchanged at $400,000. However, the sales mix shifts so that
more of Dark Chocolate is sold than of White Chocolate.

Dark Chocolate White Chocolate Total

Sales ................................... ₱300,000 100% ₱100,000 100% ₱400,000 100.0%
Variable expenses .............. 210,000 70% 40,000 40% 250,000 62.5%
Contribution margin........... ₱ 90,000 30% ₱ 60,000 60% 150,000 37.5%
Fixed expenses ................... 141,750
Net operating income ........ ₱ 8,250

Overall CM Ratio = Total Contribution Margin

Total Peso Sales
= ₱150,000
₱400,000
= 37.50%

Breakeven sales = Fixed expenses

Overall CM Ratio
= ₱141,750
37.50%
= ₱378,000