AC222 2023 2 Cost-Volume-Profit-Analysis

Introduction
• Corporate managers have a goal and that is to maximize shareholder

wealth. However, there is no clear cut course of action would lead to
the fulfillment of that goal, managers must choose a specific course of
action and develop plans and controls to pursue that course.
• Planning is future oriented, uncertainty may arise, therefore,
information helps reduce the uncertainty.
• Controlling is making actual performance align with plans, and
information is necessary in that process.
• Much of the information managers use to plan and control reflects
relationships among product cost, selling prices and sales volumes.
Introduction
• The focus of this lecture is on understanding how cost, volume, and profit
interact.
• Managers having good understanding of these relationships helps in
predicting future conditions (planning) as well as in explaining, evaluating,
and acting on results (controlling).
• Before a company generate a profit, a company must first reach its break-
even point. Then, by linking cost behaviour and sales volume, managers
can use the cost-volume profit model to plan and control.
• This topic will also discuss about the concepts of safety and degree of
operating leverage. Information provided by these models helps managers
focus on the implications that volume changes would have on
organizational profitability.
Cost-volume-profit analysis is a managerial accounting technique used to analyze the
relationship between sales volume, costs, and profit. It helps businesses understand the
impact of changes in these factors on their profitability. CVP analysis is particularly useful
for making decisions related to pricing, product mix, and sales strategies.
To understand CVP analysis, we need to consider the following components:
1. Sales Revenue: This refers to the total revenue generated from the sale of goods or
services.
2. Variable Costs: Variable costs are directly linked to the production or sale of goods or
services and vary in proportion to changes in sales volume. Examples of variable costs
include direct materials, direct labor, and variable overhead costs.
3. Fixed Costs: Fixed costs are expenses that do not change with changes in sales volume.
Examples of fixed costs include rent, salaries, insurance, and depreciation.
CVP Analysis
4. Contribution Margin: The contribution margin is calculated by subtracting

variable costs from sales revenue. It represents the amount of revenue that
contributes to covering fixed costs and generating profit.
5. Break-Even Point: The break-even point is the level of sales volume at

which total revenue equals total costs, resulting in zero profit. At this point,
the business neither makes a profit nor incurs a loss.
6. Profit or Loss: Profit is earned when total revenue exceeds total costs,
while a loss occurs when total costs exceed total revenue.
Now, let's look at an example to illustrate how CVP analysis works: A simple example
ABC Manufacturing Company produces and sells a product for K50 per unit. The variable cost per
unit is K30, and the fixed costs amount to K50,000 per month.
1. Contribution Margin per Unit:

Sales Price per Unit - Variable Cost per Unit
K50 - K30 = K20
2. Contribution Margin Ratio:

Contribution Margin per Unit / Sales Price per Unit
K20 / K50 = 0.4 or 40%
3. Break-Even Point in Units:

Fixed Costs / Contribution Margin per Unit
K50,000 / K20 = 2,500 units
4. Break-Even Point in Sales Dollars: •
Break-Even Point in Units * Sales Price • Total Fixed Costs:
per Unit K50,000
2,500 units * K50 = K125,000
• • Total Contribution Margin:
5. Profit Calculation: • Total Sales Revenue - Total Variable
Let's say the company sells 3,500 units Costs
in a month. K175,000 - K105,000 = K70,000
•
Total Sales Revenue: • Profit:
3,500 units * K50 = K175,000 • Total Contribution Margin - Total
• Fixed Costs
Total Variable Costs: K70,000 - K50,000 = K20,000
3,500 units * K30 = K105,000
Analysis
• This example demonstrates how to calculate the break-even point

and determine the profit or loss based on a specific sales volume. It
shows that ABC Manufacturing Company needs to sell at least 2,500
units to cover all costs and achieve a break-even point. Selling more
than 2,500 units results in a profit, while selling fewer units leads to a
loss.
• CVP analysis provides valuable insights into the relationships between

costs, volume, and profit. By understanding these relationships,
businesses can make informed decisions about pricing strategies, cost
management, production levels, and sales targets.
Here are a few additional concepts and considerations related to CVP analysis:
1. Margin of Safety: The margin of safety represents the difference between actual sales and the break-even
point. It indicates the cushion a company has before it starts incurring losses. A larger margin of safety provides
more flexibility and protection against unexpected changes in sales volume.
Margin of Safety Percentage:

Margin of Safety / Actual Sales * 100
2. Target Profit Analysis: CVP analysis can also be used to determine the sales volume needed to achieve a
specific target profit. By setting a desired profit level, businesses can calculate the required sales volume or
sales revenue to reach that target.
Target Sales Volume:

(Fixed Costs + Target Profit) / Contribution Margin per Unit
3. Assumptions and Limitations: CVP analysis relies on certain assumptions, such as constant sales mix, fixed
costs within the relevant range, and linear relationships between costs and volume. It's important to recognize
these assumptions and limitations when applying CVP analysis to real-world scenarios.
•
4. Multiple Product Analysis: CVP analysis can be extended to analyze scenarios involving
multiple products with different selling prices, variable costs, and contribution margins. In
such cases, the weighted average contribution margin is calculated to determine the
overall break-even point and profitability.
5. Sensitivity Analysis: CVP analysis can be used to conduct sensitivity analysis by assessing
the impact of changes in key variables on profitability. By analyzing different scenarios and
considering factors like changes in selling prices, variable costs, or fixed costs, businesses
can evaluate the sensitivity of their profitability to various factors and make informed
decisions accordingly.
• It's important to note that CVP analysis provides a simplified model of a business's
financial performance and is most useful in the short term when certain assumptions
hold. As circumstances change, such as shifts in market demand or cost structures, it's
important to reassess and update the analysis.
• CVP analysis is a valuable tool for understanding the relationship between sales volume,
costs, and profit. It enables businesses to make informed decisions about pricing, cost
management, and overall profitability. By carefully applying and interpreting CVP
analysis, managers can optimize their business operations and achieve their financial
goals.
THE END!!!

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Introduction

• Corporate managers have a goal and that is to maximize shareholder

To understand CVP analysis, we need to consider the following components:

4. Contribution Margin: The contribution margin is calculated by subtracting

5. Break-Even Point: The break-even point is the level of sales volume at

1. Contribution Margin per Unit:

2. Contribution Margin Ratio:

3. Break-Even Point in Units:

• This example demonstrates how to calculate the break-even point

• CVP analysis provides valuable insights into the relationships between

Margin of Safety Percentage:

Target Sales Volume:

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