Chapter 3 CPV Latest For Non-FinMgrs - PP
Chapter 3 CPV Latest For Non-FinMgrs - PP
Chapter 3 CPV Latest For Non-FinMgrs - PP
Cost-Volume-Profit Analysis
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Cost-Volume-Profit Analysis
What is Cost-Volume Profit Analysis?
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CVP Analysis Cont’d
The knowledge of CVP relationship is
critical to answer many management
questions related to operations such as:
What will happen to financial results
for a given change in operating
activities?
E.g. What will happen to net profit if
sales increases by 25%?
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Break-even
What is break-even ?
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Break-even
Break-even is:
a situation where total revenue of a
firm equals its total costs or net
profit is zero.
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Break-even Point
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Break-even Point
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Break-even Point
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Break-even Point
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Break-even Point
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Margin of Safety
The margin of safety shows how far sales
can fall below the planned level before
losses occur.
Margin of safety can be stated in units,
birr sales or in percentage.
Margin of Safety in:
Units -> Planned Unit Sales – BE Unit Sales
Birr -> Planned sales in Br – BE sales in Br
%-age-> Excess of planned over BE sales/Planned sales
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Margin of Safety
Activity 1
If a company with BE sales of 300,000
units plans to sale 500,000 units, what
is the margin of safety in units and
percentage? Interpret it.
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Margin of Safety
Solution for Activity 1
Its margin of safety is 200,000 units (which
is 500,000 less 300,000),
or
It can be said that actual sales of the
company can drop by 40%
(=200,000/500,000) before the company
incurs a loss, other things being equal.
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Demonstration on CVP Analysis
Demonstrative Data
Consider the following data of an
assembly plant of pocket calculators
operating in Addis:
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Contribution –Margin Technique
The break-even point is reached when
enough units are sold to generate a total
contribution margin (CM)that equals to the
total fixed costs (FC).
This implies that:
Total CM = Total FC
Or
Total Revenue = Total Costs
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Contribution –Margin Technique
A formula for this purpose can be the following:
Break-even point in units= Total fixed costs
(BEP in units) CM per unit
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Contribution –Margin Technique
For the pocket assembling firm, the relationship
between sales and variable costs looks like this:
Per unit Percent
Selling Price Br 50 100%
Variable Costs/ Unit 30 60
Contribution Margin/ Unit Br 20 Br 40 %
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Contribution –Margin Technique
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Contribution –Margin Technique
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Contribution –Margin Technique
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Techniques of Computing BEP
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The Equation Technique
• Let X= the number of units to be produced
and sold to break-even. Then,
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The Equation Technique
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The graphic technique
Break-even Chart
1,600,000 Profit
region
1,400,000
Br
1,200,000 BEP 10,000
units or
1,000,000 500,000 Br. Fixed Cost
Total Costs
800,000
Loss
Total
600,000
region Revenue
400,000
200,000
0
0 1000 Number of10000
5000 Units Sold 20000 30000
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Changes in BEP
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Changes in BEP
The key variables that change the break-
even-point are:
1. Fixed costs and
2. Contribution margin per unit
o Changes in selling price
o Changes in variable costs per unit or both.
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Change in BEP
Activity 2
If the fixed costs of our example firm
increases by 10%, what will happen to the
break-even point both in units and birr
sales?
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Change in BEP
That is,
New T. Fixed Costs= Br 200,000 * 1.1 = Br220,000
– New BEP in units = 220,000/20 = 11,000 units
– New BEP in birr = 220,000/0.4 = Br 550,000
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Change in BEP
• Note that BEP increase by 10%, i.e. units
increases from 10,000 to 11,000 and birr
sales increases too, from Br 500,000 to Br
550,000.
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Change in BEP
i) Change in variable costs per unit.
How variable costs are linked to
BEP?
Activity 3
If variable costs per unit
decreased by Br 5.00 per unit,
everything else remains the same,
what will happen to BEP?
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Change in BEP
Solution for Activity 3
New variable cost per unit = Br 30- 5= Br 25
New CM/ unit = Br 50-25= Br 25
New BEP in unit = 200,000/25 = 8,000
New BEP in birr = 200,000/0.5 = Br 400,000
Activity 4
If the selling price decreased by Br
4.00, keeping other things constant,
what will happen to BEP?
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Change in BEP
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Change in BEP
OR
BEP in units Times Selling Price= 12,500 * 46= 575,000
• (The difference birr 43 is the result of rounding error).
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Target Sales for Planned Profit
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Target Sales for Planned Profit
Activity 5
If our example firm plans to earn birr
500,000 profits during the coming
year, what is the target sales volume in
units and in Birr sales to earn the
desired profit?
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Target Sales for Planned Profit
Solutions for Activity 5
Two approaches:
(1) The Total Approach.
• It seeks for the total target sales volume.
Target sales = (Total FC +Target NP)/ CM per unit
in units
= (Br 200,000 + 500,000)/20 =35,000 units
Target sales in Br =(T. FC + Target NP)/ CM ratio
= (Br 200,000+ 500,000)/0.4
= Br 1,750,000
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Target Sales for Planned Profit
(2) The Incremental Approach
– Emphases on the incremental or additional sales
needed over and above the break-even level sales
to earn the desired net profit.
Target sales in units = BEP in units +
Target Net Profit/ CM per unit
= 10,000 units + Br 500,000/20 =35,000 units
Target sales in birr = BEP in birr +
Target Net Profit/ CM ratio
= Br 500,000 + Br 500,000/ 0.4 = Br 1,750,000
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Profit Planning with Tax
The Impact of Tax on Profit Planning
How tax influences the target sales
volume?
• Will it increase or decrease the target (or
desired) sales volume?
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Profit Planning with Tax
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Profit Planning with Tax
Activity 6
o If our pocket calculator producing
company is subjected to a 20% tax rate
and planned to earn Birr 500,000 after tax
profit during the current year, what level of
sales in birr and units would enable the
firm to earn the targeted net after tax
profit?
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Profit Planning with Tax
Solutions for Activity 6
Target sales in Birr
Recall that the variable cost percentage is 60%:
(variable cost /sales) OR
(1- CM percent)
Let S = Target sales in birr
S – 0.6S – 200,000 = 500,000/ (1- 0.2)
0.4S = 625,000 +200,000
S= 825,000/0.4 = Br 2,062,500
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Profit Planning with Tax
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Sales Mix Analysis
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Sales Mix Analysis
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Sales Mix Analysis
Sales mix is so important in
planning for two reasons:
i. A change in product mix will change the
cost-volume-profit relationships.
ii. When actual sales mix of a firm is
different from the planned sales mix,
actual profit will be different from the
targeted profit, other things being equal.
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Sales Mix Analysis
Activity 7
Consider the following sales mix and
other planned data for the current year
of a company, a company that produces
two different models of pocket calculators.
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Sales Mix Analysis
Model
W R Total
Sales in units 500,000 100,000 600,000
Sales @Br 20 and 30 Br 10,000,000 3,000,000 13,000,000
Var. exp.@ Br16 and 21 8,000,000 2,100,000 10,100,000
Cont. M. @ Br4 and 9 Br 2,000,000 900,000 2,900,000
Fixed Expenses 1,450,000
Net Income Br1,450,000
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Sales Mix Analysis
Solution for Activity 7
The sales mix from the above relationship can be
formulated as follows: 5R= W or R= W/5
Where,
W= the number of model W pocket calculators produced
R= the number of model R pocket calculators produced
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Sales Mix Analysis
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Sales Mix Analysis
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Sales Mix Analysis
What has happened?
Though the firm produced and sold the same
total number units, 600,000 (=520,000+80,000)
as was planned, because of the change in the
sales mix the actual net income has become Br
1,350,000 instead of Br 1,450,00: Br100,000
short of targeted profit.
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Sales Mix Analysis
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It is Over!
Thanks.
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