CVP Analysis, Break Even CVP Analysis, Break Even Point & Applications Of Point & Applications Of

Marginal CostingMarginal Costing

Presented By:-Presented By:- Leena KakkarLeena Kakkar Manjot SinghManjot Singh

Vijay MehtaVijay Mehta

DefinitionDefinition

Cost Volume Profit Analysis Cost Volume Profit Analysis (CVP Analysis) (CVP Analysis) is one of the most is one of the most powerful tools that managers have powerful tools that managers have at their command. It helps them to at their command. It helps them to understand the relationship between understand the relationship between cost, volume, and profit in an cost, volume, and profit in an organization by focusing on organization by focusing on interactions among the different interactions among the different elements.elements.

These five elements are:-These five elements are:-

Price of productsPrice of products Volume or Level of activityVolume or Level of activity Per unit variable costPer unit variable cost Total fixed costTotal fixed cost Mix of product soldMix of product sold

CVP Analysis help managers to take CVP Analysis help managers to take various decisions regarding business various decisions regarding business i.ei.e::

What product to manufacture or sellWhat product to manufacture or sell What pricing policy to followWhat pricing policy to follow What marketing strategy to employWhat marketing strategy to employ What type of productive facilities to What type of productive facilities to

acquireacquire

Components of CVP Components of CVP Analysis are:-Analysis are:-

Level or volume of activityLevel or volume of activity Unit selling pricesUnit selling prices Variable cost per unitVariable cost per unit Total fixed costTotal fixed cost Sales MixSales Mix

AssumptionsAssumptions

CVP assumes the following:CVP assumes the following: Constant sales price;Constant sales price; Constant variable cost per unit;Constant variable cost per unit; Constant total fixed cost;Constant total fixed cost; Constant sales mix;Constant sales mix; Units sold equal units produced.Units sold equal units produced.

LimitationsLimitations CVP is a short run, marginal analysis CVP is a short run, marginal analysis It assumes that unit variable costs and unit revenues It assumes that unit variable costs and unit revenues

are constant, which is appropriate for small deviations are constant, which is appropriate for small deviations from current production and sales.from current production and sales.

Assumes a neat division between fixed costs and Assumes a neat division between fixed costs and variable costs, though in the long run all costs are variable costs, though in the long run all costs are variable. variable.

For longer-term analysis that considers the entire life-For longer-term analysis that considers the entire life-cycle of a product, one therefore often prefers cycle of a product, one therefore often prefers activity-based costing or throughput accounting.activity-based costing or throughput accounting.

The following formula’s are used to The following formula’s are used to solve profit/volume ratio:-solve profit/volume ratio:-

P/V Ratio= Contribution/SalesP/V Ratio= Contribution/Sales

or, P/V Ratio = Fixed Cost + Profit/Salesor, P/V Ratio = Fixed Cost + Profit/Sales

or, P/V Ratio = Change in Profit or or, P/V Ratio = Change in Profit or Contribution/ Change in SalesContribution/ Change in Sales

ExampleExample

Sales Rs. 1,00,000Sales Rs. 1,00,000

Profit Rs. 10,000Profit Rs. 10,000

Variable cost 70%Variable cost 70%

Find out (i) P/V Ratio, (ii) Fixed Cost, Find out (i) P/V Ratio, (ii) Fixed Cost, (iii) Sales volume to earn a profit of (iii) Sales volume to earn a profit of Rs. 40,000Rs. 40,000

Break Even PointBreak Even Point

The break even point (BEP) is the The break even point (BEP) is the point at which cost or expenses and point at which cost or expenses and revenue are equal: there is no net revenue are equal: there is no net loss or gain, and one has “broken loss or gain, and one has “broken even”. A profit or a loss has not been even”. A profit or a loss has not been made, although opportunity costs made, although opportunity costs have been paid, and capital has have been paid, and capital has received the risk-adjusted.received the risk-adjusted.

Methods of computing Methods of computing BEPBEP

Equation ApproachEquation Approach Contribution approachContribution approach Graphical ApproachGraphical Approach

ApplicationsApplications

The break even point is one of the The break even point is one of the simplest yet least used analytical simplest yet least used analytical tools in management.tools in management.

It helps to provide a dynamic view of It helps to provide a dynamic view of the relationships, between sales, the relationships, between sales, cost and profit.cost and profit.

LimitationsLimitations Break Even analysis is only a supply side (i.e costs Break Even analysis is only a supply side (i.e costs

only) analysis, as it tells you nothing about what sales only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these are actually likely to be for the product at these various prices.various prices.

It assumes that fixed cost (FC) are constant .Although It assumes that fixed cost (FC) are constant .Although this is true in short run, an increase in the scale of this is true in short run, an increase in the scale of production is likely to cause fixed cost to rise.production is likely to cause fixed cost to rise.

In multi-product companies. It assumes that the In multi-product companies. It assumes that the relative proportions of each product sold and relative proportions of each product sold and produced are constant (ie.,the sales mix is constant).produced are constant (ie.,the sales mix is constant).

The following formulae’s are used to The following formulae’s are used to calculate Break Even Point:-calculate Break Even Point:-

Break Even Point (as % of capacity) Break Even Point (as % of capacity) = Fixed Cost/Total Contribution= Fixed Cost/Total Contribution

Break Even Point (in units)= Fixed Break Even Point (in units)= Fixed Cost/Selling Price Per Unit-Variable Cost/Selling Price Per Unit-Variable CostCost

Break Even Point (in sales Break Even Point (in sales value)=Fixed Cost* Sales/Sales-value)=Fixed Cost* Sales/Sales-Variable CostVariable Cost

ExampleExample

From the following information, From the following information, calculate the break even point in calculate the break even point in units and in sales value:units and in sales value:

Output = 3,000 unitsOutput = 3,000 units

Selling price per unit = Rs.30Selling price per unit = Rs.30

Variable Cost Per unit = Rs.20Variable Cost Per unit = Rs.20

Total Fixed Cost = Rs.20,000Total Fixed Cost = Rs.20,000

Applications of Marginal Applications of Marginal CostingCosting

Managerial Decision Relating to Managerial Decision Relating to Determination of Optimum Selling Price Determination of Optimum Selling Price

To check the Effect of Reducing of Current To check the Effect of Reducing of Current Price on profitPrice on profit

Choose of Good Product Mix Choose of Good Product Mix Calculation of Margin of Safety Calculation of Margin of Safety Decision Regarding to Sell goods at Different Decision Regarding to Sell goods at Different

Prices to Different Customers Prices to Different Customers

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