CVP ANALYSIS?

 The Cost -Volume-Profit (CVP) analysis is an attempt

to measure the effect of changes in volume, cost,
price and products-mix on profits.
 these variables are inter-related, each one of them, in
turn, is affected by a number of internal and external
factors.
 For instance,
 Costs vary due to choice of plant,
 Scale of operations,
 Technology ,
 Efficiency of work-force and
 Management efficiency. Etc
Managerial Decisions
 CVP relationship acquires a vital
significance for the manager facing a
wide spectrum of short-run decisions
like:
 what are the most profitable and
 what are the least profitable products?
 How does a reduction in selling prices affect
profits?
 How does volume or product-mix affect
product costs and profits?
Managerial Decisions
 How does volume or product-mix affect
product costs and profits?
 What will be the break-even point if
volume and costs change?
 How an increase in wages and /or other
operating expenses will affect profit?
 What will be the effect of plant
expansion on costs, profit and volume
of sales?
Interplay and Impact of Factors on Profit
 Price changes on net profit,
 Volume changes on net profit,
 Price and volume changes on net profit,
 an increase or decrease in variable
costs on net profit,
 Increase or decrease in fixed costs on
net profit,
 All four factors viz., price, volume,
variable costs, and fixed costs on net
profit.
Numerical
 Normal sales volume is 2,00,000 units
at a selling price of Rs. 2 per unit;
 capital investment is Rs. 2,00,000 and
management expects to earn a fair
return on it:
 fixed costs are Rs. 1,60,000;
 variable expenses are Re. 1 per unit.
 What would be the impact on profit :
 IfSelling Price changes by
 (a) 10%, (b) 20%
Working Notes
Particulars Normal
Volume
Units 2,00,000
Sale (Rs.) 4,00,000
Variable cost (Rs) 2,00,000
Marginal Income (Rs.) = (Sales-Variable Cost) 2,00,000
Fixed costs (Rs.) ' 1,60,000
Net Profit (Net Loss) = MC-Fixed Cost 40,000
Net Profit ( Net loss) = Net Profit/ Investment .20
per unit ( Rs.)
% change in profit

Return on investment (%) 20%

Break-even point rupee = FC/ M.I. * Sales 3,20,000

sales
Influence of price changes on Net Profit

Particulars Decrease in price Normal Increase in Price

20% 10% Volume 10% 20%

Units 2,00,000 2,00,000 2,00,000 2,00,000 2,00,000

Sale (Rs.) 3,20,000 3,60,000 4,00,000 4,40,000 4,80,000
Variable cost (Rs) 2,00,000 2,00,000 2,00,000 2,00,000 2,00,000
Marginal Income (Rs.) 1,20,000 1,60,000 2,00,000 2,40,000 2,80,000
Fixed costs (Rs.) ' 1,60,000 1,60,000 1,60,000 1,60,000 1,60,000

Net Profit (Net Loss) Rs (40,000) 0 40,000 80,000 1,20,000

Net Profit ( Net loss) (.20) - .20 .40 .60

per unit ( Rs.) - 200 % 100% + 100% + 200 %

% change in profit

Return on investment -20% 0% 20% 40% 60%

Break-even point rupee 4,26,667 3,60,000 3,20,000 2,93,333 2,74,286
sales
Inferences
 You may note the following from the above
situation:
(a) a 10% decrease in price reduces profit to zero,
while a 10% increase in price increases profit by
100%.
(b) with lower selling prices and a constant volume,
the break-even point increases.
 This happens because a reduction in sales
revenue on account of decrease in sales
price reduces the marginal income
(contribution).
 A much greater number of units have to be
sold in order to recover the fixed costs.
Influence of Sales Price & Variable Cost changes
on Net Profit , B.E.P. & Safety Margin
Influence of volume changes on Net Profit
Decrease in volume Normal Increase in Volume
Particulars
20% 10% Volume 10% 20%
Units 1,60,000 1,80,000 2,00,000 2,20,000 2,40,000

Sales (Rs.) 3,20,000 3,60,000 4,00,000 4,40,000 4,80,000

Variable cost (Rs.) 1,60,000 1,80,000 2,00,000 2,20,000 2,40,000

Marginal income (Rs.) 1,60,000 1,80,000 2,00,000 2,20,000 2,40,000

Fixed costs (Rs) 1,60,000 1,60,000 1,60,000 1,60,000 1,60,000

Net Profit (Rs.) - 20,000 40,000 60,000 80,000

Net Profit per unit (Rs.) -100% .11 .20 .273 .33

% change in profit 0% -50% - +50% +100%

Break-even point in (Rs.) 3,20,000 3,20,000 3,20,000 3,20,000 3,20,000

sales
 You may note here the following:
(a) 20% decrease in volume reduces
sales to the break-even point which
remains constant because variable
costs change in proportion to sales.
(b) 20% increase in volume improves
profit by 100% .
 A similar increase in price (viz., by 20%)
increases profit by 200%
Influence of changes in prices and volume on Net Profit
Particulars Increase in price Decrease in Price

20% 10% 10% 20%

and and
Decrease in Volume Normal Increase in Volume
20% 10% Volume 10% 20%
Units 1,60,000 1,80,000 2,00,000 2,20,000 2,40,000
Sales (Rs) 3,84,000 3,96,000 4,00,000 3,96,000 3,84,000
Variable costs (Rs.) 1,60,000 1,80,000 2,00,000 2,20,000 2,40,000
Marginal income (Rs) 2,24,000 2,16,000 2,00,000 1,76,000 1,44,000
Fixed costs (Rs.) 1,60,000 1,60,000 1,60,000 1,60,000 1,60,000
Net profit/(Net loss) Rs 64,000 56,000 40,000 16,000 (16,000)
Net profit per unit Rs. .40 .31 .20 .0727 (.066)
% change in profit +60% +40% - -60% -140%
Return on investment 32% 28% 20% 8% 8 % loss
Break-even point (Rs.) 2,74,286 2,93,333 3,20,000 3,60,000 4,26,667
Influence of changes in prices and
volume on Net Profit & B.E.P.
Please note in this situation that
a) the prices increase, as assumed would result in
higher profits, even if it is accompanied by a
decrease in volume of the same order.
 The reverse, however, is true of a price decrease
accompanied by a volume increase,.
b) that the break-even point would be at its lowest
when prices are increased and volume decreased
 because higher rupee volume with lower unit volume
reduces the variable cost ratio.
Effect of changes in Fixed Cost
Determination of the level of sales (Rs.)
 To achieve a given profit 
when fixed cost and P/V
ratio are known:

 To maintain the current

profit after an increase in
fixed cost when the new
fixed cost and original P/V
ratio are know:
Discuss the following terms
 Break -even Point
 Profit- volume Graph
 Contribution Margin
 Safety Margin
Break-Even Chart
Break-even Point & Max. Profit
 Figure 9.4 provides an idea of a
conventional break-even chart.
 Figure 9.5, however, depicts a situation
where sales revenue may have declined
as a result of lowering selling prices to
liquidate a higher volume of goods and
the company moves into a situation where
loss is incurred.
 The point of Maximum Profit is also shown
on the graph.
Margin of Safety vis-à-vis Fixed Cost
Profit Graph
Discuss the following terms
 Marginal Cost
 Marginal Costing
 Absorption Costing
 Difference Between Marginal Costing &
Absorption Costing
Tripura Ltd. is manufacturing three products : A, B
and C. The costs of manufacture are as follows:
Products A B C
Direct Material 3 4 5.
Direct Labour 2 3 4
Selling Price 10 15 20

Output 1,000 units 1,000 units 1,000 units'

 The total overheads are Rs. 12,000 out of which Rs. 9,000
are fixed and the rest are variable. It is decided to
apportion these costs over different products in the ratio of
output.
 Prepare a statement showing the cost and profit of each
product according to Absorption Costing.
Statement Showing Costs and Profit
(According to Absorption Costing Technique)
A B C
Per Unit Total Per Unit Total Per Total Rs.
Rs. Rs. Rs. Rs. Unit Rs.
Direct Materials 3 3,000 4 4,000 5 5,000
Direct Labour 2 2,000 3 3,000 4 4,000
Overheads: 3 3,000 3 3,000 3 3,000
Fixed
Variable 1 1000 1 1,000 1 1,000
Total Cost 9 9,000 11 11,000 13 13,000

Profit 1 1,000 4 4,000 7 7,000

Selling Price 10 10,000 15 15,000 20 20,000

Total profit Rs. 1,000+ Rs. 4,000 + Rs. 7,000 =

Rs. 12,000
Statement of Cost and Profit
(According to Marginal Costing Technique)
Product A Product B Product C
Per Unit Total Per Unit Total Per Unit Total
Rs. Rs. Rs. Rs. Rs. Rs.
Direct Material 3 3,000 4 4,000 5 5,000
Direct Labour 2 2,000 3 3,000 4 4,000
Variable overheads 1 1,000 1 1,000 1 1,000
Total Marginal Cost 6 6,000 8 8,000 10 10,000
Contribution 4 4,000 7 7,000 10 10,000
Selling Price 10 10,000 15 15,000 20 20,000

Total contribution (from the three products, A, B and C) is Rs. 21,000

Fixed Costs Rs. 9,000
Profit Rs. 12,000
 Taking the figures given in Illustration,
let us compute the amount of profit
under Marginal and Traditional Costing
systems,
 in case units sold of products A, B and
C are 900 each vis-à-vis production of
1000 units.
Statement of Profit
(Absorption Costing Systems)
A B C
Rs. Rs. Rs.
Direct Material 3,000 4,000 5,000
Direct Labour 2,000 3,000 4,000
Overheads : Variable 1,000 1,000 1,000
Total Marginal Cost 6,000 8,000 10,000
Add: Fixed overheads 3,000 3,000 3,000
Total Cost of Production 9,000 11,000 13,000
Less: Closing Stock 900 1,100 1,300
Cost of goods sold 8,100 9,900 11,700
Profit 900 3,600 6,300
Sales 9,000 13,500 18,000
Thus, total profit under
Absorption Costing is:

Rs.
Product A 900
Product B 3,600
Product C 6,300
10,800
Statement of Profit
(Marginal Costing)
A B C
Rs. Rs. Rs.
Total Marginal Cost 6,000 8,000 10,000
Less: Closing Stock 600 800 1,000
Cost of goods sold 5,400 7,200 9,000
Contribution 3,600 6,300 9,000
(Sales - Marginal Cost of Production)

Sales 9,000 13,500 18,000

Total profit under Marginal Costing

Rs.
Product A 3,600
Product B 6,300
Product C 9,000
Total 18,900
Contribution
Less: Fixed cost 9,000
Profit Rs. 9,900
 Profit →
 under Traditional Costing system is Rs. 10,800
 while it is Rs. 9,900 under Marginal Costing system.
 This is on account of the difference in valuation of
closing stock.
 The closing stock under Traditional Costing
system includes fixed cost of Rs. 900.
 That is why the profit under Traditional Costing
System is higher by Rs. 900 compared to
Marginal Costing system.
 With the data given in Illustration, we would
calculate the amount of profit or loss made by
Tripura Ltd. in the first two years of its existence,
 presuming that:
 In the. first year, it manufactures 1,000 units of
each of the products A, B and C but fails to
effect any sales.
 In the second year , it does not produce
anything but sells the entire stock carried
forward from the first year.
 The profit or loss for the first two years can be
ascertained by preparing the Profit and Loss
Account for each of these years
Tripura Ltd.
Profit & Loss Account for the 1st year
(As per Absorption Costing)
Direct Material Sales 0
A →3,000 Closing Stock 33,000
B→4,000
C→5,000 12,000
Direct Labour
A →2,000
B→3,000
C→4,000 9,000
Overheads:
Variable
A→1,000
B→1,000
C→1,000 3,000
Fixed 9,000 12,000
33,000 33,000
Tripura Ltd.
Profit & Loss Account for the 2nd year

Rs. Rs.
Opening Stock 33,000Sales
Fixed Overheads 9,000
Profit 3,000 A 10,000
B 15,000
C 20,000 45,000
45,000 45,000
Tripura Ltd.
Profit & Loss Account for the 1st year
Direct Material Sales 0
A →3,000 Closing Stock 24,000
B→4,000 Loss 9,000
C→5,000 12,000
Direct Labour
A →2,000
B→3,000
C→4,000 9,000
Overheads:
Variable
A→1,000
B→1,000
C→1,000 3,000
Fixed 9,000 12,000
33,000 33,000
Tripura Ltd.
Profit & Loss Account for the 2nd year
Rs. Rs.
Opening Stock 24,000 Sales
Fixed 9,000
Overheads
Profit 12,000 A 10,000
B 15,000
C 20,000 45,000
45,000 45,000
ABSORPTION COSTING AND MARGINAL
COSTING : DIFFERENCES
 The difference between Absorption
Costing and Marginal Costing is based
on the recovery of fixed overheads.
 The difference in valuation of inventory
under the two techniques is a consequence
of such treatment.
 However, for the sake of clarity, we are
analyzing the difference from both
angles, viz.
 Recovery of overheads and
 Valuation of stock.
Recovery of overheads
 Incase of Absorption Costing, both fixed and
variable overheads are charged to production.
 On the other hand, in Marginal Costing
 Only Variable Overheads are charged to
production while
 Fixed overheads are transferred in full to the
profit and loss account.
 Thus, in case of marginal Costing, there is
under- recovery of overheads since only
variable overheads are charged to production.
Valuation of Stocks
 In Absorption Costing stocks of work -in-progress
and finished goods are valued at works cost and
total cost of production respectively. The works cost
or cost of production is so defined as to include the
amount of fixed overheads also.
 In Marginal Costing, only variable costs are
considered while computing the value of work-in
progress or finished goods. Thus, the closing stock
in Marginal Costing is under- valued as compared
to Absorption Costing.
 But this does not result in carrying over of fixed
overheads of one period to another, as it happens
in Absorption Costing.
Marginal Costing vs Absorption Costing
Marginal Costing Absorption Costing
 Variable costs are treated
 Total Cost technique → all
as product costs. Fixed
costs are charged to
costs are treated as period
product/ process.
costs
 Inventory Valuation : Stock
 Inventory Valuation : Stock
of finished goods & WIP is
of finished goods & WIP is
valued at Total cost
valued at variable cost.
 Absorption of Overheads:
 Absorption of Overheads:
under/ over absorption
 Managerial Decision basis:
 Managerial Decision basis:
Contribution margin (Sales-
Profit
VC)
Marginal Cost

 Marginal Cost represents the amount of any

given volume of output by which aggregate
costs are changed if the volume of output is
increased by one unit.
 Marginal Cost = total variable costs= Prime
Cost + variable OHs
Marginal Costing
 The Marginal Costing technique is
based on the distinction between
product costs and period costs.
 Only variable costs are considered as
the costs of products while the fixed
costs are treated as period costs which
will be incurred during the period
irrespective of volume of output.
 Fixed costs are charged to P&L Account
for the period in which incurred.
Assumptions
 All the elements of costs can be
classified into fixed and varriable
components.
 VC/ unit remains constant.
 SP/ unit remains constant at all levels
 Fixed costs remains constant
 Volume of output is the only factor
which influences costs.
Utility of CVP Analysis
 Objective of
Financial Decisions /
Management:
 Profit Maximization
 Profit →Volume of Sales, Cost
 Break – Even Analysis