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Chapter

13
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Cost-VolumeProfit Analysis

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CVP Analysis defined:

A useful management tool that helps managers in planning for profit by way of a systematic analysis of the interrelationship among costs, volume (activity level) and profit.

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Factors Affecting Profit

If there is an increase in 1. Selling price 2. Unit variable cost 3. Fixed cost 4. Unit sales (volume) Then profit will

1. Increase 2. Decrease 3. Decrease 4. Increase

Note: In multi-product companies, a change in SALES MIX may also affect company profit.
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Underlying CVP assumptions (limitations):

Relevant range, time and linearity assumptions in Cost Behavior are also assumed in CVP analysis In case of a multi-product company, the proportions (sales mix) of unit sold will not change.
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Cost Behavior

Unit selling price is constant

Unless indicated otherwise, unit selling price is constant even if sales volume changes.

Other Sales mix is conditions remain constant constant

Labor productivity, production technology and market conditions remain constant and stable.

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CVP-related terminologies

Contribution margin (CM)

- is the difference between sales and variable cost. It is otherwise known as marginal income, profit contribution, contribution to fixed cost or incremental contribution.

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Contribution margin
CM ratio:

CM / sales or unit CM / unit selling price

in CM / in Sales

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Exercise:
Where-have-you-been Company manufactures and sells a single product. The Companys sales and expenses for a recent month follows:

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Sales (15,000 units) Less: Variable costs Contribution margin Less: Fixed Costs Profit
Determine the ff: 1. Selling price per unit 2. Variable cost per unit 3. CM ratio 4. CM per unit

P600,000 P420,000 P180,000 P150,000 P30,000

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Break-even Point (BEP)

- a level of activity, in units (break-even volume) or in pesos (break-even sales), at which total revenues equal total costs. At the break-even point, there is neither a profit nor a loss.

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Break-even Point (BEP)

BEP units = Fixed Cost / CM per unit BEP peso sales = Fixed Cost / CM ratio Unit sales with target profit = (FC + Profit (before tax) / CM per unit Peso sales with target Return on Sales = FC / (CM ratio ROS)

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Exercise: continuation.
Where-have-you-been Company manufactures and sells a single product. The Companys sales and expenses for a recent month follows:

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Sales (15,000 units) Less: Variable costs Contribution margin Less: Fixed Costs Profit

P600,000 P420,000 P180,000 P150,000 P30,000

What is the monthly break-even point in units sold and in sales pesos?
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Margin of Safety
- the difference between actual sales and break-even sales. It indicates the maximum amount by which sales could decline without incurring a loss.

Margin of Safety = Sales Break-even sales Margin of Safety ratio = Margin of Safety / Sales

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Indifference point
- the level of volume at which two alternatives being analyzed would yield equal amount of total costs or profits.

Alternative A Alternative B (Unit CM x Q ) FC = (Unit CM x Q ) FC FC + (Unit VC x Q) = FC + (Unit VC x Q)

Note: Q is the number of units (indifference point)
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Exercise: continuation..
Where-have-you-been Company currently pays its salespeople salaries for a total of P40,000 per month, but no commissions. The sales department is considering a plan whereby the salespeople would receive a 5% commission, but their salaries would fall to a total of P25,000 per month. At what sales level (unit and peso sales) is the company indifferent between the two compensation plans? Selling price is P30 per unit.
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Now, lets review the concepts previously discussed.

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Exercise:
Rock Company sells its only product at P32 per unit. Variable costs are P24 per unit and fixed costs amounted to P100,000 per month. Required: 1. If rock can sell 15,000 units in a particular month, what will be its profit? 2. What is the break-even point in units? In peso sales? 3. What unit sales are required to earn P40,000 for the month? 4. What peso sales are required to earn an after-tax profit of P32,000? Tax rate is 20% 5. If Rock is selling 20,000 units per month at P32, what is the margin of safety?

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Sales mix
- the relative combination of quantities of sales of various products that make up the total sales of a company.

Over-all BEP units = FC / weighted average CM per unit Over-all BEP peso sales = FC / weighted average CM ratio

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Degree of Operating Leverage (DOL)

- measure how a percentage change in sales will affect company profits. It indicates how sensitive the company is to sales volume increases and decreases. It is also known as operating leverage factor. DOL = Contribution margin / profit before tax

% sales x DOL =

% profit before tax

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End of presentation .

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