CVP analyses
- 1. CVP Analyses Cost-Volume-Profit Analysis; A Managerial Planning Tool
- 2. Introduction Definition: CVP analysis estimates how changes in; Costs (Variables and Fixed costs) Sales volume Price and so on …… affects on company’s profit. CVP is a powerful tool for planning and decision making in; Estimate future revenues, costs & profits Setting prices for products and services. To identify the levels of operating activity needed to avoid losses To achieve targeted profits Determining the breakeven point. Introducing a new product or service. Deciding whether to make or buy a given product or service. Determining the best product mix.
- 3. Cost-Volume-Profit Analysis Assumptions 1. Changes in sales volumes cause to cost and revenue changes Profit and costs as linear function. FC are period & VC are product cost. 2. Total costs divided into fixed costs and variable costs 3. Selling price, variable cost per unit, and fixed costs are all known and constant 4. In many cases only a single product will be analyzed. 5. If multiple products are studied, their relative sales proportions are known and constant 6. Price determining base on Total Cost and Contribution Margin
- 4. Relationship between Marginal Costs and Activity Fixed Cost: FC are constant Not affecting by activity Like, Tax, Rent Variable Cost: VC are Flexible Affecting by activity Like, Material, DL, FoH Costs Activity (unit) Fixed cost 10 20 300 Costs Activity (unit) Variable cost 10 20 300 50 90 60 30
- 5. Why C-V-P analyses are important. CVP Analysis answers bellow Strategic Questions; o Expected level of profit at a given sales volume? o Additional sales to achieve a desired level of profit? o Additional profit if variable costs in unit reduce? o Increase in sales to decrease in price to maintain the present profit level? o Sales level to cover all costs in product line? o To find out; Profit-Volume Ratio Break-Even Point Margin of Safety and more…….
- 6. Profit-Volume Ratio… P.V. Ratio shows; Rate of contribution per unit. Contribution per product as a percentage of Sales. Relationship of Contribution of Sales Contribution? Difference between Sales volume and Marginal Costs of Sales. It’s a pool of amount from which V.C. will be deducted to get profit or loss. Sales-Variables Costs=Contribution P.V. Ratio expressed with; 1. 𝑪𝒐𝒏𝒕𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝑺𝒂𝒍𝒆𝒔 ∗ 𝟏𝟎𝟎 3. 𝑪𝒉𝒂𝒏𝒈 𝒊𝒏 𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒊𝒐𝒏 𝑪𝒉𝒂𝒏𝒈 𝒊𝒏 𝑺𝒂𝒍𝒆𝒔 ∗ 𝟏𝟎𝟎 2. 𝑪𝒐𝒏𝒕𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝒑.𝒖 𝑺𝒂𝒍𝒍𝒊𝒏𝒈 𝒑𝒓𝒊𝒄𝒆 𝒑.𝒖 ∗ 𝟏𝟎𝟎 4. 𝑪𝒉𝒂𝒏𝒈 𝒊𝒏 𝑷𝒓𝒐𝒇𝒊𝒕 𝑪𝒉𝒂𝒏𝒈 𝒊𝒏 𝑺𝒂𝒍𝒆𝒔 ∗ 𝟏𝟎𝟎
- 7. Profit-Volume Ratio… How to improve P.V. Ratio? P.V. Ratio can be improve if contribution improve and contribution can be improve if… i. _____ Sale Price increased ii. _____ Reduce Marginal Cost by efficient us of 3M iii. _____ Concentrating on Sales with better P.V. Ratio Limitation? Following limitation should be borne in mind while using P.V. Ratio. i. _____ PVR rely on excess of revenues over variable costs. ii. _____ PVR fails taking into capital outlays required by - additional productive capacity and fixed costs added.
- 8. Break- Even Point (BEP) BEP is defining as; Volume of output where neither profit is made nor loss is incurred. Level of operation where total revenue equals total cost. Sales at BEP= Variable Cost+Fixed Cost BEP is express with; 1. 𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕 𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 ∗ 𝟏𝟎𝟎 (BEP in Percentage) 2. 𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕 𝑺𝑷𝒖−𝑽𝑪𝒖 or 𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕 𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝑴𝒂𝒓𝒈𝒊𝒏 (BEP in Unite) 3. 𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕 𝑷.𝑽.𝑹𝒂𝒕𝒊𝒐 (BEP at Sales Value)
- 9. Break- Even Point (BEP) Determining BEP; Equation Method: BEP can be determined by algebra method, Like ; Sale=Variable Cost+Fixed Cost+Profit Sales at BEP=Variable Costs+Fixed Costs Formula Method: BEP can be determined by contribution Margin, Here contribution is the deference between Selling price and Variable Cost as shown in earlier slide Graphic Method: PEB has been draw in graph where; Sales volume is shown on x-axis Value in Afghanis is shown on y-axis Total Cost line and Sales line interact each other in BEP point.
- 10. Margin of Safety BEP Graphic Method. Sales volume related Cost is shown on x-axis Value or Unit in Afghanis is shown on y-axis Total Cost line and Sales line interact each other in BEP point. Costs Total Cost BEP 0 Sales revenue Activity in units 500200 Fixed Cost 1500
- 11. Margin of Safety MoS Ratio refers to; Sales in excess of the BEP volume. Difference between Sales at given level and Sales at BEP The Margin of Safety is the units sold or revenue earned above the BEP volume. e.g. If the BEP for a firm is 200 units and the firm is currently selling 500 units, then the MoS is 300 units. Costs Sales revenue at BEP= 200 MOS= 300 units BEP 0 Current Sales revenue =500 units Activity in units 500200
- 12. Margin of Safety MoS Ratio is calculating by following formulas; 1. MoS= Actual Sales-BEP or 𝑝𝑟𝑜𝑓𝑖𝑡 𝑃.𝑉.𝑅𝑎𝑡𝑖𝑜 2. As percentage of Total Sales; 𝑀𝑜𝑆 𝑇𝑜𝑡𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 ∗ 100 where MoS= Currents Sales-BEP The Margin of Safety can be improved by, Keep BEP at lowest level and Actual Sales at highest level Increase in Sales Price Keep low the total cost costs Discontinue unprofitable products in Sales mix.
- 13. Desired Target Target Net Profit: o CVP analysis can be used to determine the level of sales needed to achieve a desired level of profit. Finding the desired profit involves: Revenue planning: determine the revenue required to achieve a desired profit level. Cost planning: find the value of the required variable cost or fixed cost to achieve the desired profit at the assumed sales quantity. Accounting for the effect of income taxes. o It’s calculating via following formula; 𝑺𝒂𝒍𝒆𝒔 = 𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕 + 𝑻𝒂𝒓𝒈𝒆𝒕 𝑷𝒓𝒐𝒇𝒊𝒕 𝑪𝒐𝒏𝒕𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝑴𝒂𝒓𝒈𝒊𝒏
- 14. Degree of operating leverage (DOL) Operating leverage is the use of fixed costs to extract higher percentage changes in profits as sales activity changes. If fixed costs are used to lower variable costs , Contribution margin increases and operating income decreases, then the degree of operating leverage increases. Calculating of DOL: Can be measured for a given level of sales by taking the ratio of contribution margin to operating income, as follows: 𝐷𝑂𝐿 = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
- 15. Multiple-Product Cost-Volume-Profit Analysis Most firms produce and sell a number of products or services. Where they use multiple product CVP analyses to find; Sales Mix BEP quantity for each product or product line. Package unit contribution Margin. e.g. Alokozi Company produces and sells two products: Alokozi Drinks and Alokozi Tea. In the coming year, Alokozi to sell 3,000 units of Alokozi Drink and 1,500 units of Alokozi Tea. Information on the two products is as follows: Alokozai Drinks Alokozai Tea Price $120 $200 Variable cost per unit 40 80 Total fixed cost is $140,000. Required: 1. What is the sales mix of AD to AT? 2. Compute the break-even quantity of each product.
- 16. SUMMARY OF LEARNING OBJECTIVES Determine the break-even point in number of units and in total sales Afghanis. At BEP, total costs (variable and fixed) equal total sales revenue. BEP units equal total fixed costs divided by the contribution margin (Price-VC) BEP revenue equals total fixed costs divided by the contribution margin ratio. Determine the number of units that must be sold, and the amount of revenue required, to earn a targeted profit. Units to earn target profit , total fixed costs plus target profit divided by contribution Sales revenue to earn target profit, total fixed costs plus target profit divided by the contribution margin ratio. Profit-volume and a cost-volume-profit graph, and explain the meaning of each. Profit-volume graphs plot the relationship between profit (operating income) and units sold. Break-even units are shown where the profit line crosses the horizontal axis. CVP graphs plot a line for total costs and a line for total sales revenue. The intersection of these two lines is the break-even point in units.
- 17. SUMMARY OF LEARNING OBJECTIVES Apply cost-volume-profit analysis in a multiple-product setting. Multiple-product analysis requires the expected sales mix. Break-even units for each product will change as the sales mix changes. Increased sales of high contribution margin products decrease the break-even point. Increased sales of low contribution margin products increase the break-even point. The impact of risk, uncertainty, and changing variables on cost-volume-profit analysis. Uncertainty regarding costs, prices, and sales mix affect the break-even point. Sensitivity analysis allows managers to vary costs, prices, and sales mix to show various possible break-even points. Margin of safety shows how far the company’s actual sales and/or units are above or below the break-even point. Operating leverage is the use of fixed costs to increase the percentage changes in profits as sales activity changes.
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