Cost - Volume Profit(CVP) Analysis

Prof. (Dr.) Gourav VallabhXLRI Jamshedpur

CVP Analysis It is a technique that may be used by management accountant to evaluate how cost and profits are affected by changes in the volume of business activities.

It is also referred as What if analysis i.e. What if there is a Change in selling price, or sales volume, or sales mix, or fixed cost etc?

The CVP analysis focuses attention on short run effect only because in the short run the level of output is restricted to that available from the current operating capacity.

As in the short run most of the costs and selling price would have already been determined and major area of uncertainty will be sales volume so CVP analysis highlights the effect of change in sales volume on the profit of firm in the short run.

Techniques of CVP analysisThere are two basic techniques of CVP analysis:1. Contribution Margin Analysis

2. Break Even Analysis

Contribution Margin AnalysisContribution Margin (Rs.) = Sales - Variable CostContribution Margin Ratio or P/V Ratio = Selling Price - Variable CostSelling Pricex 100

Breakeven Analysis* Breakeven Equation:

Sales = Variable Cost + Fixed Cost* BEP (in units) = Fixed CostContribution Margin Per Unit* BEP (in Rs.) = Fixed CostP/V Ratio

It is the difference between the actual sales and the breakeven sales for a given period.

In other words it indicates by how much the sales can decreasebefore the firm incurs the loss.

There are two firms A Ltd. and B Ltd.. The sales and cost information for these two firms are given below:

A Ltd.B Ltd.Sales (Units)10,00010,000Selling Price (per)Rs. 20Rs. 20Variable Cost (per)Rs. 15Rs. 10Fixed CostRs. 40,000Rs. 90,000

Analyze the cost information.

Margin of Safety:

It is formed at the intersection of total cost line and total sales line.

The size of the angle of incidence is indication of quantum of profit or loss made by firm at different output/sales level.

A narrow angle of incidence show a slow rate of profit earning while a wider angle of incidence indicate a swift rate of profit earning capacity of the firm.

A narrow angle also indicates that a variable cost as a proportion to sales is quite high and therefore very little has been left by way of contribution.

Angle of Incidence:

From the following figures, find the break-even volume:

Selling price (per tonne)Rs. 69.50Variable cost (per tonne)Rs. 35.50Fixed ExpensesRs. 18,02,000

If this volume (BEP) represents 40% capacity, what is the additional profit for an added production of 40% capacity above the current level, the selling price of which is 10% lower and for 20% capacity above the 80% capacity, the selling price of which is 15% lower than the existing price.Problem

The factor of production which in short supply is called as key factor or limiting factor.

The decision regarding profitability of the product in such situation is based upon profitability of key factor

Profitability of the key factor =

Contribution per unitConsumption of key factor per unit (either in Rs or in unit of factor of production Higher the profitability of key factor, better the product Key Factor / Limiting Factor -

Sales in unit - Check Contribution per unit - higher better.

Sales in Rs - Check P/V ratio - higher better.

Raw Material - Check profitability of raw material - higher better.

Time / Labour / Capacity - Check profitability of labour - higher better.Main key factors -

Product A Product B Product CStandard Cost per unit:Direct Materials (Rs.)103020Variable Overheads (Rs.)325Direct Labour:DepartmentRate per hourHoursHoursHoursXRe. 0.50281630Y1.005610Z0.5016830Product AProduct B Product CData from current budget:Production per year10,0005,0006,000Selling Price per unit (Rs.)506890Fixed Overheads per year (Rs. 2,00,000)Forecast of maximum possiblesale for the year12,0007,0009,000*ContinuedProblem The Board of Directors of Fortunate Ltd., manufacturing three Products A, B and C have asked for the advice on the production mixture of the company

However, the type of labor required by Department Y is in short supply and it is not possible to increase the manpower of the department beyond its present level.

You are required to prepare a statement of the most profitable mixture of the products to be made and sold. The statement should show:

(i) the profit expected on the current budgeted production; and

(ii) the profits which could be expected if the most profitable mixture was produced.*Concluding Part