Economics of Business

Enterprises

Cost-Volume-Profit Analysis

(Renner Péter, BGF–Külkereskedelmi Főiskolai Kar)

 Cost-Volume-Profit Analysis

Examining shifts in
costs and volume

and their resulting effects on profit.

 Cost-Volume-Profit Analysis

It is applicable in all economic sectors:

●
manufacturing,
●
wholesaling,
●
retailing,
●
service industries
Cost-Volume-Profit Analysis

It can be used by managers to

●
plan and
●
control.
 Cost-Volume-Profit Analysis
Break-even point:
that level of activity,
at which total revenues
equal total costs.

R TR
C TC
BEP

q
 Cost-Volume-Profit Analysis
Assumptions:
Revenue: total revenue fluctuates in direct proportion to
output. Revenue per unit remains constant.
Variable costs: total variable costs fluctuate in direct
proportion to level of activity or volume. Variable costs per
unit remains constant.
Variable production costs: direct materials, direct labour, R
TR
variable overhead C TC
Variable selling costs: charges for items such as commissions BEP VC
and shipping FC
Variable administrative costs: may exist in areas such as q
purchasing
Fixed costs: remain constant within the relevant range (Fixed
factory overhead, fixed selling and administrative expenses)
Mixed costs: must be separated into their variable and fixed
elements.
 Cost-Volume-Profit Analysis
Contribution margin (CM) on a per-unit basis:
●
difference between the selling price per unit and the
variable production, selling and administrative costs per
unit.
CM = P – CV
●
indicates the amount of revenue that remains after all
variable costs have been covered.
R TR
C TC
Total contribution margin (TCM): BEP VC
difference between total revenues and total variable FC
costs for all units sold:
TCM = TR – TVC q
 CVP Analysis – Case Study
California Winery Inc. sells wine
relevant range: 4,000 to 15,000 cases per year.
Total Per unit Percent
$ $ %
Sales [12,000 cases] 1,080,000 90 100
Variable Costs
Production 324,000 27 30
Selling 108,000 9 10
Total variable cost 432,000 36 40

Contribution Margin 648,000 54 60

Fixed Costs
Production 250,000
SGA 25,400
Total Fixed cost 275,400

Profit Before Tax 372,600

 CVP Analysis – Case Study
California Winery Inc. sells wine
relevant range: 4,000 to 15,000 cases per year.
Total Per unit Percent
$ $ %
Sales [12,000 cases] 1,080,000 90 100
Variable Costs
Production 324,000 27 30
Selling 108,000 9 10
Total variable cost 432,000 36 40

Contribution Margin 648,000 54 60

R, C
Fixed Costs [$] TC
Production 250,000
SGA 25,400 VC
Total Fixed cost 275,400 275.4 FC

Profit Before Tax 372,600

4k 15k q [units]
 1350 R[$] TR
CVP Analysis – Case 1080
Study
360
California Winery Inc. sells wine
4k 12k 15k q [units]
relevant range: 4,000 to 15,000 cases per year.
VC[$] TR
Total
$ VC
540
Sales [12,000 cases] 1,080,000 432
Variable Costs 144
Production 324,000 4k 12k 15k q [units]
Selling 108,000
1350 R, VC[$] TR
Total variable cost 432,000
540 VC
Contribution Margin 648,000
144
Fixed Costs 4k 12k 15k q [units]
Production 250,000
FC
SGA 25,400
[$]
Total Fixed cost 275,400
275.4 FC
Profit Before Tax 372,600
4k 12k 15k q [units]
 CVP Analysis – Case Study

R, C[$] TR
1350

Profit
TC

BEP
459
FC
275.4
Los s
4k 5.1k 15k q [units]
12k

Traditional Approach
 CVP Analysis – Case Study

R, C[$] TR
1350

Profit
TC

VC
540
BEP
459
FC
275.4
Los s
4k 5.1k 15k q [units]
12k

Contemporary Approach
 CVP Analysis – Case Study

Profit [$]

Profit

372.6

0
4k 5.1k 15k q [units]
12k
FC = -275.4
Los s

Contemporary Approach
 Cost-Volume-Profit Analysis
Total Revenue Contribution margin ratio:
– Total Variable Cost CM/R
Total Contribution Margin
– Total Fixed Cost indicates what proportion of
Profit/Loss selling price remains after
variable costs have been
R(x) = FC + VC(x) + PBT covered [(R –VC)/R].
R – VC = CM
R = revenue per unit (selling price)
x = number of units
R(x) = total revenue
FC = total fixed cost
VC = variable cost per unit TR, TR
TC
VC
VC(x) = total variable cost VC
PBT = profit before tax FC
q
 Cost-Volume-Profit Analysis
Usage of Cost-Volume-Profit analysis
Price (R) is generally given by the market. Managers want to
have a certain amount of profit (target profit):

known unknown
R, FC, VC, PBT Q (= x)
R, FC, Q, PBT VC

PAT = PBT – CT
CT = PBT × CTR/100
PBT = PAT/(1 – CTR)
PAT = Profit After Tax
CT = Corporate Tax
CTR = Corporate Tax Rate
 Cost-Volume-Profit Analysis
Fixed amount of Profit
R TR
R(x) = FC + VC(x) + PBT C TC
R(x) – VC(x) = FC + PBT BEP
VC
x = (FC + PBT) / (R – VC)
FC

q
offset
R TR
TC'
C TC
VC
FC+PBT
FC

x q
 Cost-Volume-Profit Analysis
Variable amount of profit
R TR
As units sold, profit will increase C TC
at a constant rate BEP
VC
(given percent
before-tax profit on sales). FC

R(x) = FC + VC(x) + PBT(x) q

x = FC / (R – VC – PBT)
R TR
TC'
C
gradient TC
(VC+PBT)(x)
VC

FC

x q
 Cost-Volume-Profit Analysis
Income statement approach

Total Revenue (SALES)

– Total Variable Cost
Total Contribution Margin
– Total Fixed Cost
Profit Before Tax
 Cost-Volume-Profit Analysis
Incremental Analysis for
Short-run Changes
What happens if one or more
factors changes?
●
If we spend $20k more on
advertising, we can sell an R TR
additional 300 units. C
TC
●
If we reduce the price to $80
from 90, we can sell an additional BEP VC
300 units.
●
We can sell an additional 100 FC
units for $110, if we spend $10k.

q
 Cost-Volume-Profit Analysis
CVP Analysis in a Multi-product Environment
Necessary to assume a constant product sales mix, or an average
contribution margin ratio (“bag” assumption):
Whenever some of product A is sold,
a set amount of of Product B and C is also sold.
(The fixed cost can be (has to be) split up between products.)
 Cost-Volume-Profit Analysis
Margin of safety
Margin of Safety in Units = Actual Units – Break-even Units
Margin of Safety in $ = Actual Sales $ – Break-even Sales $
Margin of Safety in Units or $
Margin of Safety (%) =
Actual Sales in Units or $
R TR
C
TC

BEP VC

FC

q
 Cost-Volume-Profit Analysis
Operating leverage
relationship between variable and fixed costs
VC FC operating level CM ratios
high low low highly labour intensive
low high high highly capital intensive high
Contribution Margin
Degree of Operating Leverage =
Profit Before Taxes
R TR R TR
C TC C TC
BEP BEP
VC
FC
FC
VC

q q

Contribution margin ratio: CM/R