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Outline What is CVP analysis The importance of CVP to use in decision making
Break-Even point ( BEP)
Contribution Margin (CM)
Contribution Margin Ratio (CMR) Target Profit
Safety Margin
CVP Analysis with single Product
What Is Sales Mix CVP Analysis with Multiple Products
Assumptions of CVP Analysis
Limitation of CVP
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What is CVP analysis
The cost-volume-profit study is the manner of how toevolve the total revenues, the total costs and operatingprofit, as changes occur in volume production, saleprice, the unit variable cost and / or fixed costs of aproduct.
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The importance of CVP to use in decision
makingManagers use this analysis to answer different questionslike: How will incomes and costs be affected if we stillsell 1.000 units? But if you expand or reduce sellingprices? If we expand our business in foreign markets ?The cost-volume-profit is a necessary tool for forecastingalso for management control. Cost volume profit analysis(CVP analysis) is one of the most powerful tools thatmanagers have at their command.
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Break-Even point ( BEP)
Break even point is the level of sales at which profit iszero. According to this definition, at break even pointsales are equal tofixed cost plusvariable cost . Thisconcept is further explained by the following equation:
[Break even sales = fixed cost + variable cost]TR-TC=Profit TR-TC=0
Where: Q= output and P=price
if: (Q*P)-TFC-(Q*UVC)=0 (Q*P)-(Q*UVC)-TFC=0Q(P-UVC)=TFC
Q=TFC/P-UVC
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Assumption of (BEP)
The Break-even Analysis depends on three keyassumptions:
Average per-unit sales price (per-unit revenue)Average per-unit cost
Monthly fixed costs
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Break-Even point ( BEP)
To calculate the BEP Equation two Methods are used :A) equation method
B) Contribution Margin Method
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equation method
The format of this method can be expressed inequation form as follows:
[Profit = (Sales Variable expenses) Fixed expenses]Rearranging this equation slightly yields the following
equation, which is widely used in cost volume profit(CVP) analysis:
[Sales = Variable expenses + Fixed expenses + Profit]
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Break-Even point (Equation Method)
Q = 350 Units
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Contribution Margin
The contribution margin is total revenue minus totalvariable costs. Similarly, the contribution margin perunit is the selling price per unit minus the variable cost per
unit. Both contribution margin and contribution marginper unit are valuable tools when considering the effects of
volume on profit. Contribution margin per unit tells ushow much revenue from each unit sold can be applied
toward fixed costs. Once enough units have been sold tocover all fixed costs, then the contribution margin per unitfrom all remaining sales becomes profit.
[Contribution Margin = Sales revenue Variable cost ]CM=P-VC
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Contribution Margin method (contd)ABC company
Total Per Unit Percent
Sales : (1000 units) X 1,000,000$ 1,000$ 100%
Less: variable expense 600,000 600 60%
Contribution margin 400,000$ 400$ 40%
Less: fixed expenses 160,000
Net income 240,000$
Note:
For each additional product X sold, the company willgenerate $400 in contribution margin.
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Contribution Margin method (contd)
We can use CM method to find the BEP
BEP (in units)= FC/UCM
$160,000/$400= 400 units of product X
Total Per Unit Percent
Sales : (400 units) X 400,000$ 1,000$ 100%
Less: variable expense 240,000 600 60%
Contribution margin 160,000$ 400$ 40%
Less: fixed expenses 160,000
Net income -$
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Contribution Margin Ratio
The contribution margin as a percentage of total sales isreferred to as contribution margin ratio (CM Ratio).
Formula or equation of CM ratio is as follows:[ CM Ratio = Contribution Margin / Sales ]
Therefore in our example:
CMR= 160,000/400,000= 0.4 0r 40%
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The Importance of (CMR) The CM ratio is extremely useful since it shows how
the contribution margin will be affected by a change intotal sales. To illustrate notice that in our example has
a CM ratio of 40%. This means that for each dollarincrease in sales, total contribution margin willincrease by 40 cents ($1 sales CM ratio of 40%). Netoperating income will also increase by 40 cents,
assuming that fixed cost do not change.
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Break- Even Point in sales Formula: FC/ CMR
Therefore : 160,000/40% = $400,000 sales
Total Per Unit Percent
Sales : (400 units) X 400,000$ 1,000$ 100%
Less: variable expense 240,000 600 60%Contribution margin 160,000$ 400$ 40%
Less: fixed expenses 160,000
Net income -$
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Constructing the Break-Even Chart
100,000
200,000
300,000
400,000
500,000
600,000
200100 300 500400 600 700 Units Sold
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Target Profit analysis Question:
How many units of product X should be produced and
soled to reach a profit of$ 200,000 ? Formula:
Units sold to earn the target profit :Q= FC + Target Profit/UCM
Therefore in ABC company :160,000+200,000/ 400= 900 units
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Margin of safety (MOS)
Margin of safety (MOS): is the excess of budgeted or actualsales over the break even volume of sales. It stats the amount by
which sales can drop before losses begin to be incurred. The
higher the margin of safety, the lower the risk of not breakingeven.
Formula:
[Margin of Safety = Total budgeted or actual sales Break even sales]
The margin of safety can also be expressed in percentage form.
[MOS = Margin of safety in dollars / Total budgeted or actual sales]
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Margin of safety (MOS) Contd
Example:
The company has a BEP of $400,000. If actual sales are $1000,000 thesafety margin is: 1000,000-400,000= $600,000 or 600 units of product X
OR: 600,000/1000,000= 60% Margin of safety as a percentage of sales
Break-even
sales
400 units
Actual sales
1000 unitsSales of product X 400,000$ 1,000,000$
Less: variable expenses 240,000 600,000
Contribution margin 160,000 400,000
Less: fixed expenses 160,000 160,000
Net income -$ 240,000$
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CVP Analysis with Multiple Products
Sale mix: Definition and Explanation of the Concept:
The term sale mix refers to the relative proportion in which acompany's products are sold. The concept is to achieve the
combination, that will yield the greatest amount of profits.Most companies have many products, and often theseproducts are not equally profitable. Hence, profits willdepend to some extent on the company's sales mix. Profits
will be greater if high margin rather than low margin itemsmake up a relatively large proportion of total sales.
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Sales Mix and Break Even Analysis: If a company sells multiple products, break even
analysis is somewhat more complex .The reason is thatthe different products will have different selling prices,
different costs, and different contribution margins.Consequently, the break even point will depend on themix in which the various products are sold.
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Table of information of ABC company in August
Product 101 Product 102
Units produced and sold 12,000 8,000
Direct Material 22,000 32,000
Direct labor 15,000 12,000
Variable overhead cost 26,000 34,000
Selling price ( per unit) 34 40
total fixed costs 48,000
CVP Analysis with Multiple Products (Example)
1. To calculate BEP in September?
2. Units to be sold to obtain profit of $3o,ooo?
3. To find X= 55% and Y= 45% ?
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CVP Analysis with Multiple Products (Example)
contd (1) Formula of BEP in multiple products:
BEP=total FC/WAUCMUVC(X)=22,000+15,000+26,000/12,000=5.25
UVC(Y)=32,000+ 12,000+34,000/8,000=9.75UCM= P-UVCUCM(X)=34-5.25 =28.75UCM(Y)=40-9.75 =30.25
WAUCM =UCM* % of totalWAUCM(X)= 28.75*60%=17.25
WAUCM(Y)=30.25*40%= 12.1total of sales mix 29.35
12,000+8000=20,00012,000/20,000= 0.6
8,000/20,000= 0.4
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CVP Analysis with Multiple Products (Example)
contd BEP=total FC/WAUCM
BEP=48,000/ 29.35=1635.5X=1635.5 *0.6= 981 unitsY=1635.5 *0.4= 654 units
(2) Units to be sold to obtain $3o,ooo?BEP=total FC+P/WAUCMBEP=48,000+ 30,000/ 29.35=2,657
X=2,675*0.6=1,605 units
Y=2,675*0.4=1070 units
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CVP Analysis with Multiple Products (Example)
contd(3) X= 55% and Y= 45% ?
28.75*55% =15.8
30.25*45%= 13.6
total of sales mix 29.4
BEP=total FC/WAUCM48,000/29.4=1632
1632*55%=897 units
1632*45%=734 units
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cost volume profit analysis assumptions
1. All costs can be analysed into their fixed and variable elements.
2 . Fixed costs remain fixed even over a wide range of activity.
3. Variable costs always vary directly with activity.
4. Selling prices are constant per unit. 5 . Only levels of activity affect costs and revenues
6. usually only one product can be effectively dealt with
7. Uncertainty does not exist.
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Limitations of Cost-Volume-Profit (CVP) Analysis:
Cost volume profit (CVP) is a short run, marginalanalysis: it assumes that unit variable costs and unitrevenues are constant, which is appropriate for smalldeviations from current production and sales, and assumes
a neat division between fixed costs and variable costs,though in the long run all costs are variable. For longer-term analysis that considers the entire life-cycle of aproduct, one therefore often prefers activity-based costing
or throughput accounting.
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references
GABRIELA BUAN, IONELA-CLAUDIA DINA, USING COST-VOLUME-PROFITANALYSIS IN DECISION MAKING, Annals of the University of Petroani, Economics,9(3), 2009, 103-106
www.wiley.com/college/sc/eldenburg/ch03.pdf
http://www.accountingformanagement.com/cost_volume_profit.htm http://www.entrepreneur.com/tradejournals/article/173229705.html
http://www.accountingformanagement.com/Break_even_analysis.htm
http://www.accountingformanagement.com/contribution_margin_definition.htm
http://www.accountingformanagement.com/contribution_margin_ratio.htm
faculty.lebow.drexel.edu/KlineS/Acct601/Chap008.ppt
http://www.accountingformanagement.com/concept_of_sales_mix.htm
http://business.fortunecity.com/discount/29/cvpassweb.html, Cost Volume ProfitAnalysis: Its Assumptions and Their Pitfalls , by: Duncan Williamson
http://en.wikipedia.org/wiki/Cost-Volume-Profit_Analysis
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Thank you for pay attention
Presented by :
Meytham PoormollaKhalid Malik
Barnabas Eze
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