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COST VOLUME- PROFIT ANALYSIS

AND
BREAK-EVEN ANALYSIS

Dr. Ashok Panigrahi


Cost Classifications
Three types
Variable Cost
Fixed Cost

Mixed Cost
Variable costs
costs that vary or changes
in proportion to changes
in the level of activity.
Direct materials
Direct labor
Units Produced Direct Materials Total Direct
per unit Material Costs

5,000 units $10 $ 50,000

10,000 units $10 $ 100,000

15,000 units $10 $ 150,000


Fixed Costs
costs that remain fixed
even though the level of
activity i.e. production
level changes.
Number of Bottles Total Salary for Salary per bottle
Supervisor produced

50,000 $75,000 $1.50

100,000 $75,000 $0.75

150,000 $75,000 $0.50


Mixed Costs
has characteristics of both a variable and a fixed
cost.
Could behave as a fixed costs for part of the relevant
range and then variable cost
Cost-Volume-Profit Analysis (CVP)

Which helps them predict how changes in costs


and sales levels affect income
CVP analysis involves computing the sales level
at which a company neither earns an income nor
incurs a loss break even point
Contribution Margin Concept
Contribution margin = Sales Variable costs

Contribution margin ratio or Profit-Volume


Ratio (P/V Ratio) =
Sales Variable costs
Sales
Is most useful when the increase or decrease in sales volume is
measured in sales dollars
Unit contribution margin
= Sales price per unit Variable cost per unit
Note: Contribution Margin Ratio is otherwise
known as Profit-Volume Ratio (P/V Ratio).
Profit Volume Ratio Concept
P/V Ratio = Contribution x100
Sales
or, Sales - Variable cost x 100
Sales
or, Fixed Expenses + Profit x100
Sales
or, Change in Profit or Contribution x 100
Change in Sales
Example
The Company has sales of $1,000,000, variable costs of $800,000.
The company sold 50,000 units. Compute the contribution margin
and the contribution margin ratio.

Contribution margin = Sales Variable cost


= $1,000,000 - $800,000 = $200,000

Contribution margin ratio = (Sales VC)/Sales


= (1,000,000 800,000)/1,000,000
= 20%

Unit Contribution margin = Contribution margin


Units sold
= $200,000
50,000
= $4
Break-even Analysis
to determine the units of sales necessary to achieve the
break even pint in operations
to determine the units of sales necessary to achieve a
target or desired profit

Break-Even Point
Is the level of operations at which a businesss
total revenues and total costs are exactly equal?
A business will have neither an income nor a loss
from operations.
Break Even Point

Revenues Expenses
Break even formula

BEP = Fixed Costs


P/V Ratio or Contribution per unit
Example
Suppose that selling price is $25, variable cost $15 and fixed costs are $90,000.
What is break even point?

BEP = Fixed costs / Unit Contribution Margin


= $90,000/ (25 15) = $90,000/$10 = 9,000 units

At sales level of 9,000 units will result in no gain or loss to the company.

Proof:
Sales: ($25 X 9,000) $225,000
Variable cost: ($15 x 9,000) 135.000
Contribution margin 90,000
Fixed costs 90,000
Operating income -0-
Changes in fixed costs
Example: Suppose that selling price is $25,
variable cost $15 and fixed costs are $90,000.
What is break even point if fixed costs increase
to $100,000?

BEP = Fixed costs/ Unit Contribution margin


= $100,000/ (25-15) = 10,000 units

Due to an increase in fixed costs from $90,000 to


$100,000, break even point increased
Changes in variable costs
Example: Suppose that selling price is $25, variable cost $15
and fixed costs are $90,000. What is break even point if
variable costs decrease to $10?

BEP = Fixed costs/ Unit Contribution margin


= $90,000/ (25-10) = 6,000 units

Due to a decrease in variable costs from $15 to $10,


break even point decreased to 6,000 units from 9,000
units or a decrease of 3,000 units
Changes in selling price
Example: Suppose that selling price is $25, variable cost $15
and fixed costs are $90,000. What is break even point if
selling price increase to $30?

BEP = Fixed costs/ Unit Contribution margin


= $90,000/ (30-15) = 6,000 units

Due to an increase in sales price from $25 to $30, break


even point decreased to 6,000 units from 9,000 units or
a decrease of 3,000 units.
Desired or Target Profit
Sales = Fixed costs + Desired Profit
Unit contribution margin

Example: Suppose that selling price is $45, variable cost $30, and fixed costs are
$60,000. The company wants a desired profit of $45,000. What is break even
point and sales required?

BEP = Fixed costs / Unit Contribution margin


= ($60,000)/ (45-30) = 4,000 units

Required Sales = Fixed costs + Desired profit/ Unit Contribution margin


= ($60,000 + $45,000)/ (45-30) = 7,000 units

To create $45,000 of profit, must sell 7,000 units or 3,000 more than break even point
Charts

Costs Total cost

Variable

Fixed costs

Units
Graphical Break even point

Sales
$
Total costs
Profit

Break even point


Sales = TC
Loss

0 Units
Graphical Break even point
Sales Mix Consideration
More than one product is
sold at varying selling prices
Products often have different
unit variable costs
Products have different
contribution margin
Sales volume necessary must
a mix of both products
Example :
Cascade Co produces two products X and Y. X
has a selling price of $90 per unit and variable
cost of $70. Y has a selling price of $140 and
variable cost of $95. Fixed costs are $200,000.
Xs sales are approximately 80% of total sales
for the company. What is the break even point
for the sales mix?
Example :
Product Selling Variable Contribution Sales Sales mix
Price Cost Margin % Contribution
Margin

X $90 $70 $20 80% $16

Y $140 $95 $45 20% $9

Sales $25
mix
Example :
BEP = Fixed Costs
Sales mix CM

= $200,000
$25

BEP = 8,000 units

Of what products:

X : 8,000 units * 80% = 6,400 units


Y : 8,000 units * 20% = 1,600 units
Margin of Safety
Indicates possible
decrease in sales that may
occur before an
operating loss occurs.

Margin of Safety Ratio =


Sales Sales at BEP
Sales
Margin of Safety
If sales are $400,000 and sales at break even are
$300,000 what is margin of safety?

MS = Sales Sales BEP = $400 - $300


Sales $400
= 25%
High-Low Method
Cost estimation 3. Find the difference in
techniques total units from highest to
lowest level of production
Steps
4. Variable cost per unit
1. Find the highest and Difference in Total cost
lowest level of production Difference in Total units
2. Find the difference in 5. Find fixed cost by solving
total cost from highest to this equation
lowest level of production Total cost = Fixed cost
plus Variable cost
Example

Month Production Total Cost


June 1,000 $45,550
July 1,500 $52,000
Aug 2,100 $61,500
Sept 1,800 $57,500
Oct 750 $41,250
Example
Step 1: Find highest and lowest level of production.
Month Units Total Cost

High August 2,100 $61,500


Low October 750 $41,250

Step 2: Get the difference


Difference 1,350 $20,250
Example continued
Step 3: Compute Variable cost per unit
Variable cost = Difference in Total Cost
Difference in Units

=$20,250
1,350

= $15 per unit


Total cost = FC + VC
$61,500 = FC + ($15 *2,100 units)
$61,500 = FC + 31,500
FC = $30,000
Example Contd
Step 4: Compute Fixed costs
Total cost = Fixed Costs + Variable Cost
using the data at 2,100 units of production, we
solve for fixed costs
$61,500 = FC + ($15 *2,100 units)
$61,500 = FC + 31,500
FC = $30,000
Example Continued
Given the information in the prior slide, what is
the total cost at 2,000 units of output?

Total cost = Fixed costs + Variable costs


Total cost = $30,000 + ($15 X 2,000)
Total cost = $60,000