COST-VOLUME-PROFIT (CVP) ANALYSIS

CVP ANALYSIS - is a profit planning tool that deals with the relationship of profit with costs and sales volume.
CONTRIBUTION MARGIN (CM) is a measure of company’s ability to cover variable costs with revenues. It is
also known as marginal income, profit contribution, contribution to fixed cost or incremental contribution.
• CM = Sales – Variable Costs
• Unit CM = Unit Selling Price – Unit Variable Costs
• CM Ratio = CM ÷ Sales = Unit CM ÷ Unit Selling Price = Δ CM ÷ Δ Sales
CM Ratio is also known as marginal ratio or profit-volume (P/V) ratio.
BREAK-EVEN POINT (BEP) is the sales level at which profit is zero (i.e., total revenues = total costs).
• BEP (units) = Fixed Costs ÷ Unit CM
• BEP (peso sales) = Fixed Costs ÷ CM Ratio
• BEP Ratio = BEP ÷ Sales
• Sales (units) with Target Profit = (Fixed Costs + Target Profit*) ÷ Unit CM
• Sales (peso sales) with Target Profit = (Fixed Costs + Target Profit*) ÷ CM Ratio
• Sales (peso sales) with Target Profit Ratio = Fixed Costs ÷ (CM Ratio – Profit Ratio)
* Target Profit must be expressed before tax: Pre-tax Profit = After-tax Profit ÷ (100% - tax rate)
MARGIN of SAFETY is the maximum amount by which sales could decrease without incurring a loss.
• Margin of Safety (MS) = Sales – Breakeven Sales = Profit ÷ CM Ratio
• MS Ratio = MS ÷ Sales = Profit Ratio ÷ CM Ratio = 100% - BEP Ratio
Like the break-even point, safety margin can also be expressed in units or in peso sales.
INDIFFERENCE POINT is the level of volume at which total costs or profits are the same between two
alternatives under consideration.
Alternative A Alternative B
• Cost-based: Fixed Costs + (Unit VC x Q) = Fixed Costs + (Unit VC x Q)
• Profit-based: (Unit CM x Q) – Fixed Costs = (Unit CM x Q) – Fixed Costs
Legend: Q – number of units (indifference point)
SALES MIX (a.k.a. product mix) is the proportion of different products that comprise the company’s total sales.
• Overall BEP (units) = Fixed Costs ÷ Weighted Average Unit CM
• Overall BEP (peso sales) = Fixed Costs ÷ Weighted Average CM Ratio
DEGREE of OPERATING LEVERAGE (DOL) measures how sensitive the profit is to sales volume increases and
decreases. It is also known as operating leverage factor.
• DOL = CM ÷ Profit before tax = Δ% in profit before tax ÷ Δ% in Sales = 1 ÷ MS Ratio
CVP analysis assumptions and limitations
✓ Behavior of both sales and costs is linear and predictable throughout the entire relevant range of activity
and within a specified time span.
✓ Fixed costs, unit variable costs, selling price and sales mix must behave as constants.
✓ There are no changes in inventory levels (i.e., production equals sales).
✓ Volume is the only factor affecting sales, variable costs and profit.
✓ Time value of money is ignored.
EXERCISES: COST-VOLUME-PROFIT (CVP) ANALYSIS
1. KLM Company sells a single product. The company’s sales and expenses for a recent month follows:
Sales (1,500 units) P 37,500
Less: Variable Costs 15,000
Contribution Margin P 22,500
Less: Fixed Costs 15,000
Profit P 7,500
REQUIRED:
1. Determine the following:
A) Unit selling price B) Unit variable cost C) CM ratio (CMR)
2. For profit planning purposes, compute the following:
A) Break-even point in units B) Break-even peso sales
3. What is the margin of safety at its present sales of P 37,500?
4. What unit sales are required to earn P 12,000 profit for the month?
5. What peso sales are required to earn an after-tax profit of P 7,200 (tax rate: 20%)?
6. What peso sales are required to reach a 10% return on sales or profit margin ratio?
7. Assuming KLM is currently selling 800 units per month and the company president believes that
sales would increase if advertising were increased by P 6,000. How many units should sales
increase to give KLM the same profit or loss that it is currently earning?
(NOTE: Although current sales of 800 units are given, you need not use this info to solve the
problem.)
8. At present, KLM pays its salespeople a monthly salary of P 4,000 without any commission. It
considers a plan whereby salespeople receive a 10% commission, but their monthly salary would fall
to P 2,500. What sales level will KLM be indifferent between the two compensation plans?
2. Tarlac Company sells two products, tables and chairs. Following is income budget for next month:
Chairs Tables Total
Unit sales 60 u 15 u 75 u
Sales P 750.00 P 300.00 P 1,050.00
Variable Costs 600.00 225.00 825.00
Contribution Margin P 150.00 P 75.00 P 225.00
Fixed Costs 90.00
Profit P 135.00
REQUIRED:
1. How many units of chairs should be sold next month to break-even?
2. How many units of tables should be sold to earn a profit of P 120?
3. Sir K has recently opened a fitness gym. The income statement for its first year of operations follows:
Sales P 250,000
Variable Costs (100,000)
Contribution Margin P 150,000
Fixed Costs (120,000)
Profit P 30,000
Sir K is not happy about the results of his gym’s first year of operations. He observed that despite the high
contribution margin, profit was still low because of the high fixed costs. He therefore concludes that an
increase in sales would not result a satisfactory increase in profit.
REQUIRED:
1. Explain to Sir K that his conclusion is not right by computing the operating leverage factor.
2. If sales increase by 10%, then how many percent would profit increase, ceteris paribus?
(NOTE: determine the percentage Δ in profit by using the operating leverage factor.)

4. Bicol’s break-even sales are P 528,000. The variable cost ratio is 60% while the profit ratio is 8%.

REQUIRED: Determine the following: