Cost volume profit analysis.

Cost Volume Profit (CVP).
Introduction
Fixed costs
Variable costs
Semi variable costs
Contribution margin
Break even point
PV Ratio
BEP ANalysis.
break even point
Cost-volume-Profit.

1. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 11
Module 12.
Cost Volume
Profit Analysis
Dr. Varadraj Bapat
Indian Institute of Technology,
Mumbai
[email protected]
9892413119

2. Dr. Varadraj BapatDr. Varadraj Bapat
CA., CWA., M.Com., DISA, PhD.CA., CWA., M.Com., DISA, PhD.
School of ManagementSchool of Management
Indian Institute of Technology, MumbaiIndian Institute of Technology, Mumbai
Teaching Interests: Teaching Interests: Financial Accounting, Financial Accounting,
Management Accounting, Indian EconomyManagement Accounting, Indian Economy
Research Interests: Research Interests: Financial Accounting, Financial Accounting,
Financial Inclusion, Corporate FinanceFinancial Inclusion, Corporate Finance
Others: Others: Yoga, Spirituality, Sanskrut, Bharatiya Yoga, Spirituality, Sanskrut, Bharatiya
Sanskriti, ABVPSanskriti, ABVP

3. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 33
Cost Volume Cost Volume
Profit (CVP)Profit (CVP)

IntroductionIntroduction

Fixed costsFixed costs

Variable costsVariable costs

Semi variable costsSemi variable costs

Contribution marginContribution margin

Break even pointBreak even point

PV RatioPV Ratio

4. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 44
CVP AnalysisCVP Analysis
CVP analysis is the analysis of three CVP analysis is the analysis of three
variable viz. cost, volume and profit. variable viz. cost, volume and profit.
Such analysis explores the Such analysis explores the
relationship existing amongst costs, relationship existing amongst costs,
revenue, activity level and resulting revenue, activity level and resulting
profit. It aims at measuring variation of profit. It aims at measuring variation of
cost with profit.cost with profit.

5. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 55
Fixed CostFixed Cost
These are the costs which incurred These are the costs which incurred
for a period and which within certain for a period and which within certain
output and turnover limits, tend to output and turnover limits, tend to
be unaffected by fluctuations in the be unaffected by fluctuations in the
levels of activity (Output or levels of activity (Output or
turnover). turnover).

6. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 66
For example: Rent, insurance of For example: Rent, insurance of
factory building etc. remain the same factory building etc. remain the same
for different levels of production.for different levels of production.

7. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 77
Fixed Cost GraphFixed Cost Graph
Fixed Cost
Total Cost
A
m
t
Units

8. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 88
Variable CostVariable Cost
These costs tend to very with the These costs tend to very with the
volume of activity. Any increase in volume of activity. Any increase in
activity results in an increase in the activity results in an increase in the
variable cost and vice versa. variable cost and vice versa.
For example: Cost of direct labour, For example: Cost of direct labour,
direct material, etc. direct material, etc.

9. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 99
Variable Cost Variable Cost
GraphGraph
Variable Cost
`
Units

10. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 1010
These costs contain both fixed and These costs contain both fixed and
variable components and thus partly variable components and thus partly
affected by fluctuation in the level of affected by fluctuation in the level of
activity. activity.
Examples of semi variable costs are Examples of semi variable costs are
telephone bill, gas and electricity etc. telephone bill, gas and electricity etc.
Semi-Variable CostSemi-Variable Cost

11. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 1111
Semi-Variable Cost Semi-Variable Cost
GraphGraph
Semi-Variable Cost
`
Units

12. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 1212
Cost-Volume-Profit Cost-Volume-Profit
AnalysisAnalysis
CVP analysisCVP analysis::

Takes into account Takes into account
–the total costs (fixed and variable)the total costs (fixed and variable)
–the total sales revenuesthe total sales revenues
–desired profits vis-a-vis the sales desired profits vis-a-vis the sales
volumevolume

13. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 1313
It is used for forecasting or predicting It is used for forecasting or predicting
how the changes in costs and sales how the changes in costs and sales
volume affect profit. It is also known volume affect profit. It is also known
as 'Break-Even Analysis'.as 'Break-Even Analysis'.
CVP analysis could be helpful in the CVP analysis could be helpful in the
following situations:following situations:

14. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 1414
Budget planning: for forecasting Budget planning: for forecasting
profit by considering cost and profit profit by considering cost and profit
relation, and volume of production relation, and volume of production
volume. This will help in determining volume. This will help in determining
the sales volume required to make a the sales volume required to make a
profit.profit.
–To make decisions regarding To make decisions regarding
pricing and sales volume.pricing and sales volume.

15. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 1515
Determining the sales mix of different Determining the sales mix of different
products, in what proportions each of products, in what proportions each of
the the products can be soldproducts can be sold..
–Preparing flexible budget considering costs Preparing flexible budget considering costs
at different levels of productionat different levels of production

16. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 1616
Objectives of CVP Objectives of CVP
AnalysisAnalysis
–Understand the interaction Understand the interaction
amongamong

Prices of products Prices of products

Volume or level of activity Volume or level of activity

Per unit variable cost Per unit variable cost

Total fixed cost Total fixed cost

Mix of product sold Mix of product sold

17. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 1717
Assumptions of CVP Assumptions of CVP
AnalysisAnalysis
•Expenses can be classified as either Expenses can be classified as either
variable or fixed.variable or fixed.
•CVP relationships are linear over a CVP relationships are linear over a
wide range of production and sales.wide range of production and sales.
•Sales prices, unit variable cost, and Sales prices, unit variable cost, and
total fixed expenses will not vary within total fixed expenses will not vary within
the relevant range.the relevant range.

18. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 1818
•Volume is the only cost driver.Volume is the only cost driver.
•The relevant range of volume is The relevant range of volume is
specified.specified.
•Inventory levels will be unchanged.Inventory levels will be unchanged.
•The sales mix remains unchanged The sales mix remains unchanged
during the period.during the period.

19. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 1919
CalculationsCalculations
Profit Equation and Contribution Profit Equation and Contribution
MarginMargin
1.1.Profit =Sales -Total costsProfit =Sales -Total costs
2.2.Profit = Sales -Total variable costs - Profit = Sales -Total variable costs -
Total Fixed costsTotal Fixed costs
3.3.Contribution margin = Total revenue – Contribution margin = Total revenue –
Total variable costsTotal variable costs

20. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 2020
SalesSales XX XX
-Variable Cost-Variable Cost (XX)(XX)
ContributionContribution XX XX
-Fixed Cost-Fixed Cost (XX)(XX)
ProfitProfit XX XX

21. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 2121
Profit = (S-V)*Q – FCProfit = (S-V)*Q – FC
Q = (FC + Expected Profit)Q = (FC + Expected Profit)
(S-VC)(S-VC)
Q is the no. of units required to be Q is the no. of units required to be
sold to obtain target profit.sold to obtain target profit.
S=Selling Price p.u. VC=Variable S=Selling Price p.u. VC=Variable
cost p.u. FC=Fixed Costcost p.u. FC=Fixed Cost

22. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 2222
Suppose that Super Bikes wants to Suppose that Super Bikes wants to
produce a new mountain bike called produce a new mountain bike called
Hero1 and has forecast the following Hero1 and has forecast the following
information.information.

Price per bike = Price per bike = ``800800

Variable cost per bike = Variable cost per bike = ` ` 300300

Fixed costs related to bike Fixed costs related to bike
production = production = `` 55,00,000 55,00,000
Example:

23. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 2323

Target profit = Target profit = `` 2,00,000 2,00,000

Estimated sales = 12,000 bikesEstimated sales = 12,000 bikes
We determine the quantity of bikes We determine the quantity of bikes
needed for the target profit as needed for the target profit as
follows:follows:

Quantity = (Quantity = (``55,00,000 + 55,00,000 + ``2,00,000) / 2,00,000) /
((``800 - 800 - ``300) = 11,400 bikes300) = 11,400 bikes

24. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 2424
Profit Volume Ratio Profit Volume Ratio
(PV)(PV)
The contribution margin ratio (CMR) The contribution margin ratio (CMR)
i.e. PV ratio is the percentage by i.e. PV ratio is the percentage by
which the selling price (or revenue) which the selling price (or revenue)
per unit exceeds the variable cost per unit exceeds the variable cost
per unit, or contribution margin as a per unit, or contribution margin as a
percentage of revenue. percentage of revenue.

25. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 2525
ExampleExample
For Hero1, we could use the forecast For Hero1, we could use the forecast
information about volume (12,000 information about volume (12,000
bikes) to determine the contribution bikes) to determine the contribution
margin ratio.margin ratio.

Total revenue = Total revenue = ``800 * 12,000 800 * 12,000
= = `` 96,00,000 96,00,000

26. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 2626

Total variable cost Total variable cost
= = `` 300* 12,000 = 300* 12,000 = `` 36,00,000 36,00,000

Total contribution margin = Total contribution margin =
``9,600,000 - 9,600,000 - `` 3,600,000 = 3,600,000 =
``6,000,0006,000,000

Contribution margin ratio = Contribution margin ratio =
``6,000,000 / 6,000,000 / ``9,600,000 =0.6259,600,000 =0.625

27. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 2727
BEP analysisBEP analysis

Breakeven analysis is used to find Breakeven analysis is used to find
the minimum level of production the minimum level of production
required required

Evaluates both fixed and variable Evaluates both fixed and variable
costscosts

28. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 2828

Uses:Uses:
1.1.To find a suitable product mixTo find a suitable product mix
2.2.To find the sales required to reach To find the sales required to reach
a desired revenue.a desired revenue.
3.3.The profits at certain price level The profits at certain price level
and salesand sales

29. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 2929
Break even Point (BEP)Break even Point (BEP)

A CVP analysis can be used to A CVP analysis can be used to
determine the BEP, or level of determine the BEP, or level of
operating activity at which revenues operating activity at which revenues
cover all fixed and variable costs, cover all fixed and variable costs,
resulting in zero profit.resulting in zero profit.

In other words this is the point where In other words this is the point where
no profit or losses have been madeno profit or losses have been made

30. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 3030
Cost-Volume-Profit GraphCost-Volume-Profit Graph
Fixed expensesFixed expenses
Units Sold
S
a
l
e
s

i
n

R
u
p
e
e
s
Total expensesTotal expenses
Total salesTotal sales
Break-evenBreak-even
pointpoint
Break-evenBreak-even
pointpoint
Profit area
Loss area

31. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 3131
Break even Break even
ApplicationsApplications
•New Product decisions :-
Enables to determine the sale
volume required for a firm
(or an individual product) to
breakeven , given expected sales
price and expected costs.
•Pricing decisions:- Enables to
study the effect of changing price
and volume relationship on total
profits.

32. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 3232
•Modernizations or automation
decisions:- Analysis the profit in
implication of a modernization or
automation programme.
•Expansion Decisions :- studies
the aggregate effect of a general
expansion in production and
sales.

33. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 3333
FormulaeFormulae

BEP in units = Total fixed costsBEP in units = Total fixed costs
(Sales price – variable cost p.u.)(Sales price – variable cost p.u.)
= Fixed cost= Fixed cost
Contribution per unitContribution per unit

BEP in sales value = Fixed cost BEP in sales value = Fixed cost
PV RatioPV Ratio

34. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 3434
ExampleExample
•SalesSales5000 units5000 units
•Sales price per unit Rs. 50Sales price per unit Rs. 50
•Variable cost per unit Rs. 30Variable cost per unit Rs. 30
•Fixed cost Rs. 35000Fixed cost Rs. 35000
• Therefore, contribution per unit = Therefore, contribution per unit =
50-30 =Rs. 2050-30 =Rs. 20

35. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 3535
BEP in units = 35000/20 BEP in units = 35000/20
= 1750 units = 1750 units
1750 * 50 = Rs. 875001750 * 50 = Rs. 87500

BEP in sales value = 35000 * BEP in sales value = 35000 *
250000 / 87500250000 / 87500
= Rs. 100000= Rs. 100000

36. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 3636
Margin of safetyMargin of safety
•Represents the strength of the Represents the strength of the
businessbusiness
•Margin of Safety= Actual Sale –Margin of Safety= Actual Sale –
BEP SaleBEP Sale
•Margin of safety% = (Sales - Margin of safety% = (Sales -
BEP)/Sales x 100BEP)/Sales x 100

37. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 3737
•Margin of safety = (5000-1750) Margin of safety = (5000-1750)
5000 5000
=65% =65%
•Hence even if the sales decrease by Hence even if the sales decrease by
65%, the business wont face any 65%, the business wont face any
lossloss

38. Dr. Varadraj Bapat, IIT MumbaiDr. Varadraj Bapat, IIT Mumbai 3838