Cost-Volume-Profit Relationsships
Cost-volume-profit analysis is one of the most powerful tools that helps managers understand the
inter-relationship between cost, volume and profit.
Elements of C-V-P Analysis
1. Sales
2. Volume or level of activity within the relevant range
3. Variable cost per unit
4. Total fixed costs
5. Sales mix
Assumptions of CVP Analysis
1. The analysis is valid for a limited range of values
2. All costs are classifiable as fixed or variable
3. Revenues change proportionately with volumes with selling price remaining constant
4. Total fixed costs are constant over the relevant range, but fixed cost per unit vary inversely with the
cost driver
5. Total variable costs change directly with the cost driver, but variable cost per unit are constant over
the relevant range
6. Production equals sales, there is no change in inventory
7. Selling prices unit and market conditions remain unchanged
8. Constant product mix
Relevant Range- range of activity level or series of volumes within the expected behavior of cost is
valid
Illustrative problem: The following information was taken from the records of ABC Company:
Selling Price: 10
Variable Cost: 6
Fixed Cost: 150,000
Number if units sold: 50,000
Contribution margin per unit- is the excess of unit selling price over unit variable costs and the
amount each unit sold contribute toward covering fixed costs and providing profits.
Selling price per unit: 10 Sales Ratio: 100%
Variable cost per unit: 6 Variable cost ratio (6/10) 60%
Contribution margin: 4 Contribution margin Ratio 40%
Contribution margin ratio- is the percentage of contribution margin to sales
Break-even analysis
Break-even point- the sales volume level (in pesos or in units) where total revenues equals total
costs, that is, there is no profit nor loss.
A. Algebraic Method
B. Contribution margin method
1. Break-even point in units (BEP)= Total Fixed Costs/ CM Per Unit
2. Break-even point un pesos (BEP)= Total Fixed Costs/ CM Ratio
3. Break-even sales for multi-products firm (units)= Total Fixed Costs/ Weighted Ave. CM Per
Unit
4. Break-even sales for multi-products firm (pesos)= Total Fixed Costs/ Weighted CM Ratio
BEP (u) = Total FC/CM Per Unit BEP (P) = Total FC/ CM Ratio
= 150,000/4 = 150,000/40%
= 37,500 = 375,000
Solution for the illustrative problem
Contribution Margin Income Statement Sales at Break-even
Sales (50,000* 10) 500,000 Sales (P) 375,000
Less: Less:
Variable Cost (50,000*6) 300,000 Variable Cost (37,500*6) 225,000
Contribution Margin 200,000 Contribution Margin 150,000
Less: Less:
Fixed Cost 150,000 Fixed Cost 150,000
Net Income 50,000 0
Actual Sales: 500,000 100% MS Ratio= 125,000/ 500,000= 25%
Less:
Break-even sale 375,000 75%
Margin of safety 125,000 25%
Profit= Margin of Safety * CM Ratio Profit% = MS Ratio * CM Ratio
= 125,000* 40 = 25% * 40%
= 50,000 = 10%
CVP analysis can be used to determine the level of sales needed to achieve a desired level of profit.
A. To earn a desired amount of profit before tax
Sales (U)= Fixed costs + desired profit / CM per unit
Sales (P)= Fixed costs + desired profit / CM Ratio
B. To earn a desired amount of profit after tax
Sales (U)= Fixed cost + Net Profit Sales (P)= Fixed cost + Net Profit
1-Tax Rate 1- Tax Rate
CM per Unit CM Ratio
Profit before tax= Net profit (after tax profit)/ 1- tax rate
C. To earn a desired profit ratio (profit as a percentage of the required sales)
Sales (U)= Total Fixed Costs/ CM per Unit - Profit per Unit
Sales (P)= Total Fixed Costs/ CM Ratio - Profit Ratio
Contribution margin income statement:
To check:
3,000 Profit before tax 5,850 Profit after tax
Sales( 675* 100) 67,500 (825 * 100) 82,500
Less:
Variable Cost (675* 60) 40,500 (825 * 60) 39,500
Contribution Margin 27,000 33,000
Less:
Fixed cost 24,000 24,000
Income before tax 3,000 9,000
Less:
Income tax (35%) 1,050 3,150
Income after tax 1,950 5,850
Compute for peso amount and volume of sales at break even point
Selling price 100
Variable costs and expenses 60
Fixed cost and expenses 24,000
Using the information above, compute for the peso and amount of sales and the number of units to
be sold so as to:
A. Realize a net income of 3,000 before tax
B. Realize a net income of 5,850 after income tax of 35%
CM ratio= 40/100= 40% CM per Unit= 100-60= 40
BEP (U)= 24,000/ 40= 600 unit BEP (P)= 24,000/40%= 60,000
A. Net income of 3,000 before tax B. Net income of 5,850 after tax of 35%
Sales (U)= 24,000+3,000/40 Sales (U)= 5,850/ 1-35%
= 675 = 9,000
= 24,000+ 9,000
= 33,000/ 40
= 825
Sales Mix: AB Corporation sells two products A and B at a rate of 2 units and 3 units respectively. The
following data are also shown below:
PRODUCTS
A B
Unit Selling Price 10 5
Variable Cost per Unit 6 3
Total Fixed Cost 420,000
Required:
Weighted contribution margin per unit.
Break even point in units (combined).
Weighted contribution margin ratio
Break-even point in sales (combined)
Break even point in sales pesos for 1) Product A 2) Product B
Weighted contribution margin per unit.
