Cost volume-profit (cvp)

1. Prepared by: Jessy Chong
URL: chongsk818.blogspot.com

2. CVP Analysis
 CVP (Cost-volume-profit) analysis is a term given to the study
of the interrelationships between the elements of costs and
volume over the profit of the business.
 CVP Analysis is an important short-term planning tool and
useful for decision making – Marginal Costing Principle
 Key Formulae:
Units $
BEP Fixed cost /
contribution per unit
Fixed costs / CS ratio
MOS Profit / Contribution
per unit
Profit / CS ratio
Sales
required
Fixed costs + Profit
Contribution per unit
Fixed costs + Profit
CS ratio

3. Assumptions
 CVP analysis can apply to one product only, or to more
than one product only if they are sold in a fixed sales mix
(fixed proportions).
 Fixed costs per period are same in total, and unit variable
costs are a constant amount at all levels of output and
sales.
 Sales price are constant at all levels of activity.
 Production volume = sales volume

4. Breakeven, Contribution and P/V
Charts

5. Multiple Products CVP
 To perform breakeven analysis for a multi-product organization,
either a constant sales mix must be assumed, or all products must
have the same C/S ratio.
 To breakeven point for a standard sales mix of products is calculated
by dividing the total fixed costs by the weighted average
contribution per unit, or by the weighted average C/S ratio.
 Formulae:
BEP(unit) = Fixed cost
Weighted average contribution per unit
BEP($) = Fixed cost
Weighted average C/S ratio

6. Illustration:
Hair Co (12/12)
Hair Co manufactures three types of electrical for hair: curlers (C), straightening irons
(S) and dryers (D). The budgeted sales prices and volumes for the next year are as
follows:
Each product is made using a different mix of the same materials and labour. The
budgeted sales volumes for all the products have been calculated by adding 10% to
last year’s sales.
The standard cost for each product is shown below.
Labour costs are variable. The general fixed overheads are expected to be $640,000
for the next year.
C S D
Selling price $110 $160 $120
Units 20,000 22,000 26,000
C S D
$ $ $
Materials 20 50 42
Labour 30 54 50

7. Cont’d
Required:
 Calculate the weighted average contribution to sales ratio for
Hair Co. (4 marks)
 Calculate the total break-even sales revenue for the next
year for Hair Co. (2 marks)
 Draw a multi-product profit-volume (PV) chart showing
clearly the profit/loss line assuming:
 You are able to sell the products in order of the ones with the
highest ranking contribution to sales ratios first; and
 You sell the products in a constant mix.
(9 marks)
 Note: Round all workings to two decimal
(15 marks)

8. Limitations
 It is assumed that fixed costs are the same in total and variable costs
are the same per unit at all levels of output. This is assumption is a
great simplification.
 Fixed costs will change if output falls or increases substantially (most
fixed costs are step costs).
 The variable cost per unit will decrease where economies of scale
are made at higher output volumes, but the variable cost per unit
will also eventually rise when diseconomies of scale begin to appear
at even higher volumes of output (for example the extra cost of
labour in overtime working).

9. Limitations (Cont’d)
 The assumption is only correct within a normal range or relevant
range of output. It is generally assumed that both the budgeted
output and the breakeven point lie within this relevant range.
 It is assumed that sales prices will be constant at all levels of activity.
This may not be true, especially at higher volumes of output, where
the price may have to be reduced to win the extra sales.
 Production and sales are assumed to be the same, so that the
consequences of any increase in inventory levels or of “de-stocking”
are ignored.
 Uncertainty in the estimates of fixed costs and unit variable costs is
often ignores.

10. Advantages
 Graphical representation of cost and revenue data (breakeven
charts) can be more easily understood by non-financial
managers.
 A breakeven model enables profit or loss at any level of
activity within the range for which the model is valid to be
determined, and the C/S ratio can indicate the relative
profitability of different products.
 Highlighting the breakeven point and the margin of safety
gives managers some indication of the level of risk involved.