INTRODUCTION TO

(CVP) COST VOLUME

PROFIT ANALYSIS

F.M.Kapepiso

Learning Objectives:
After studying you will learn:
The basic concepts of cost volume profit analysis.
Identifying relevant and irrelevant costs and how to use
them under different decision scenarios.

Key Terms Used:

Cost Volume Profit Analysis

Contribution
Profit Volume Ratio (Contribution margin ratio)
Break Even Point
Margin of safety
Sunk Cost
Key Factor
Relevant Cost or Revenue
Pricing Decisions
Accepting special orders
Make or buy
Cost indifference point

Some questions:
Role of management accountant in
the changing world?

Some questions:
Cost Volume Profit Analysis?
Contribution & CMR? What? How?
Why?
Break Even Point? What? How? Why?
Total sales total variable cost
Unit SP Unit variable cost
Sales X CMR
FC + Profit

Example
RADIAL LTD
Cost Volume Profit Analysis
Whether to Accept an export offer of 50 000 tablets @8per
tablet?
NOTE: 200 000 of manufacturing overheard are fixed in
nature. All admn overheads are fixed.
Income statement on next slide

RADIAL LTD
Income statement year ended 2010
Description
Sales 14 per tablet (100 000 units)
Less cost of goods sold
Manufacturing costs
Material
Labour
overheads
Gross profit
Less Administrative and selling Expenses
Net Profit

Amount
1 400 000

300 000
250 000
350 000
900 000
500 000
290 000
210 000

Statement showing effect on offer

Sales ( 100 000 X 14) & (100 000X

14 + 50 000X8)

Without
export
offer

With
export
offer

1 400 000

1 800 000

700 000

1050 000

700 000

750 000

490 000

490 000

210 000

260 000

Less variable costs

Material

300 000

Labour

250 000

Overheads

150 000

Contribution
Less fixed costs
Manufacturing

200 000

Administration & selling exp..

290 000

Net profit

Cost Volume Profit Analysis:

Cost volume profit analysis is a technique used to determine the
effects of change in selling prices, costs and volume over
profits.
Contribution: known as contribution margin also, it is difference
between revenue and the variable cost of earning that revenue.
Formula:
S-V=C=F+P
(Selling priceVariable cost=Contribution=Fixed costs + Profits)

Profit Volume Ratio: Known as contribution margin ratio

also, it indicates contribution margin as percentage of sales.
To calculate this ratio contribution per unit is divided by
selling price per unit or total contribution is divided by total
sales revenue,
symbolically
CMR = Contribution 100
Sales

Alternative formula for CMR

CMR can be calculated using the following formula.
CMR = Profit
Sales

means absolute change in profits or sales

Example:
The following information relates to two years sales and
profit for Saheli Restaurant
Description
Sales
Profit

2003
450000
90000

2004
600000
150000

CMR=60000/150 000=0.4 OR 40%

Contribution = sales X CMR = 600000 x 0.4 = 240000
FC = 240000 150000 = 90000
BEP = FC/CMR = 90000/0.4 = 225000

Activity
Description
2004
Sales
500000
Profit
50000
Fixed cost?

2003
350000
(10000)

 CMR = 60000/150000 = 0.4

Contribution = 500000 x 0.4 =
200000
S-V=C=F+P
200000 = F + 50000
F = 200000 50000 = 150000
(Selling priceVariable Cost
=Contribution=Fixed costs + Profits)

Break Even Point: A company breaks even for a period

when sales revenue is equal to total cost of that period or
in other words contribution equals the fixed costs.
BEP (units) =Fixed cost
Contribution per unit OR

TFC
C

BEP (Dollars): = BEP (units) x selling price per unit

BEP (N$) = Total fixed cost
CMR

TFC
CMR

Margin of safety calculated using the following formula.

MS = Profit
CMR
Required sales to earn desired net income
(a) Sales (units) = TFC + Desired profit
C per unit
(b) Sales (value) = answer (a) x selling price per unit
OR
TFC + Desired profit
CMR

Example
Let us assume that Radial wants to earn annual income
of 350000 from domestic market than the required sales to
earn the desired profit will be calculated as given below.
Sales (tablets) = 490000(F) + 350000(DP)
7
= 120000 tablets
Sales (N$) = 120000 x 14 per tablet = N$1680000
OR
490000 + 350000 = N$1680000
0 .5

2. Calculating required sales to earn desired profit after

tax:
Remember that DP in above formula is profit before tax.
Therefore, if the target income is net of tax or after tax,
the same should be first converted into profit before tax
by using the following formula.
Profit before tax = Profit after tax / (1 tax rate*)
* tax rate in decimal form

Activity
Using previous example information:
Calculate sales (N$); if Radial wants
to earn after tax profit of N$ 300000
and tax rate is 25%
N$ 1780000
Or
1780000 / 14 = 127143 units Approx.

Example: Change in selling price

Let us assume that Radial is facing a tough competition and
has to decrease its selling price by N$ 1 per tablet.
After price reduction the company wants to earn profit of
230000.
Required sales to earn desired profit will be ascertained as
follows:
New contribution per unit = 13-7 = 6 per tablet
Required sales = 490000 + 230000 = 120000 tablets
6
Required sales (N$) = 120000 x13 = 1320000
NB: similarly you can analyse the effect of change in other
factors.

Assumptions of CVP analysis

Selling price, variable cost per unit and total fixed cost
remain unaffected by increase or decrease in sales
volume.
Firm is able to sell more units without affecting the cost
structure.
In multi product situations, product mix is known in
advance and remains constant.
Costs can be accurately classified in to fixed and
variable categories.

THE END