Management Accounting -
Cost Volume Profit (CVP) Analysis with Example
Cost-volume-profit (CVP) analysis is the study of the effects of changes in costs and volume on a company’s profits.
Break-even point:
A break-even point is the point where the total revenues is equal to total costs i.e. there is zero profit.
How to calculate Break-even point:
(1) Equation Method:
Formula: Sales- Variable Cost- Fixed Cost = Net Profit
(2) Contribution Margin Method:
Formula:
Break-even point (in units) = [Fixed Cost/ Contribution margin per unit]
Break-even point (in Taka) = [Fixed Cost/ Contribution ratio]
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Example 1:
ABC manufacturing company has a product selling price per unit is Taka 100; Variable Cost per unit is Taka 40; Fixed Cost is Taka 60,000.
Calculate Break-even point (in units) using (a) Equation method and (b) Contribution margin method.
Solution:
(a) Equation Method:
Sales- Variable Cost- Fixed Cost = Net Profit
=> 100Q - 40Q -60,000 = 0 [Let, Sales Quantity = Q]
=> 60Q = 60,000
=> Q = 10,000
Break-even point (in units) = 10,000
(b) Contribution Margin Method:
Contribution margin per unit= Selling price per unit - Variable Cost per unit
=100 - 40
=60
Break-even point (in units) = [Fixed Cost/ Contribution margin per unit]
=60,000/60
=10,000
Break-even point (in units) = 10,000
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Margin of Safety:
Margin of Safety is the difference between the actual or expected sales units and break-even sales units.
Targeted Profit:
Targeted Profit is the profit a company target to achieve it in its specific sales units.
Example 2:
ABC manufacturing company has a product selling price per unit is Taka 100; Variable Cost per unit is Taka 40; Fixed Cost is Taka 60,000.
Calculate Break-even point (in Taka) using (a) Contribution margin method, (b) Margin of Safety and Margin of Safety ratio assuming actual sales amounting Taka 3,00,000 and (c) Sales (in Taka) required to earn net income of 1,50,000.
Solution:
(a) Contribution Margin Method:
Contribution margin per unit= Selling price per unit - Variable Cost per unit
=100 - 40
=60
Contribution margin ratio= Contribution margin per unit/ Selling price per unit
=60/100
=60%
Break-even point (in Taka) = [Fixed Cost/ Contribution margin ratio]
=60,000/60%
=1,00,000
Break-even point (in Taka) = 1,00,000
(b) Margin of Safety:
Margin of Safety = Actual sales - Break-even Sales in Taka
= 3,00,000 - 1,00,000
= 2,00,000 (Taka)
Margin of Safety ratio= Margin of Safety in Taka/ Actual sales in Taka
= 2,00,000/ 3,00,000
= 66.67%
(C) Sales (in Taka) required to earn net income of 1,50,000
= (Fixed Cost+ Targeted Income)/ Contribution margin ratio
= (60,000+ 1,50,000) / 60%
= 3,50,000
Sales (in Taka) required to earn net income of 1,50,000 is Taka 3,50,000.
Example 3:
ABC Company makes printers that sell for Taka 4,000 each. For the coming year, management expects fixed costs to total Taka 4,400,000 and variable costs to be Taka 1,800 each.
(a) Compute break-even point in units using the mathematical equation.
(b) Compute break-even point in Taka using the contribution margin (CM) ratio.
(c) Compute the margin of safety percentage assuming actual sales are Taka 10,000,000.
(d) Compute the sales required in Taka to earn net income of Taka 2,200,000 using the mathematical equation.
Solutions:
(a) Sales = Variable costs + Fixed costs + Net income
4,000 Q= 1,800 Q+ 4,400,000+0
=> (4,000-1,800) Q=4,400,000
=> 2,200 Q= 4,400,000
=> Q= 2,000
Break-even point in units= 2,000 printers.
(b) Contribution margin per unit= Unit selling price - Unit variable costs
= 4,000- 1,800
= 2,200
Contribution margin ratio= Contribution margin per unit / Unit selling price
= 2,200 / 4,000
= 55%
Break-even point in Taka= Fixed cost / Contribution margin ratio
= 4,400,000 / 55%
= 8,000,000
Break-even point in Taka 8,000,000
(c) Margin of safety= (Actual sales – Break-even sales)/ Actual sales
= (10,000,000/ 8,000,000)/ 10,000,000
= 20%
(d) Required sales = Variable costs + Fixed costs + Net income
= 4,000 Q= 1,800 Q+ 4,400,000+ 2,200,000
=> (4,000-1,800) Q=6,600,000
=> 2,200 Q= 6,600,000
=> Q= 3,000
Sales required in Taka= 3,000 units* Taka 4,000 each
= Taka 12,000,000