COST-VOLUME-PROFIT (CVP) Analysis

COST-VOLUME-PROFIT (CVP) Analysis
CVP Analysis is a systematic examination of the relationships among cost, volume (cost driver), and
profit.
ELEMENTS OF CVP ANALYSIS
• Sales • Total fixed costs
• Selling price • Variable costs per unit
• Units or volume • Sales mix
DEFINITION OF TERMS
Break-even point is the point (sales volume level in pesos or

in units) where operationally, there is neither profit nor loss.
This is the point where total revenue equals total variable costs
and total fixed costs.
Contribution margin is the difference between the entity’s

sales and total variable costs. If selling price per unit is
deducted with the variable cost per unit, the difference is
called contribution margin per unit. When contribution
margin is divided to sales, a percentage is obtained called
contribution margin ratio.
Margin of safety is the difference between actual or

budgeted sales and break-even sales. This is the amount
of peso sales or the number of units by which actual or budgeted
sales may be decreased without resulting into a loss.
Margin of safety ratio is MOS divided by the actual or budgeted

sales or by providing profit ratio by the contribution margin ratio.
Sales mix is the combination of

products that, in total, will compose
the reported sales of an entity with
multiple product lines.
KEY ASSUMPTIONS IN CVP ANALYSIS
1. All costs are classifiable as either variable or fixed.

2. Cost and revenue relationships are predictable and linear over a relevant range of activity and a
specified period of time.
3. Total variable costs change directly with the cost driver, but variable costs per unit are constant
over the relevant range.
4. Total fixed costs are constant over the relevant range, but fixed costs per unit vary inversely with
the cost driver.
5. Selling prices per unit do not change as sales volume changes.
6. Inventory levels remain constant (i.e., production equals sales).
7. If the company sells multiple products, sales mix is constant.
8. The time value of money is ignored.
CONTRIBUTION MARGIN METHOD
SCM Company sells its products at P200 per unit. Variable cost per unit includes P75 in
materials, P40 in labor, P15 in variable overhead, and P10 in variable selling and administrative
expenses. Fixed costs per period amounts to P750,000.
1. How much is the contribution margin per unit?
2. What is the contribution margin ratio?
3. How many units should the entity sell to break-even?
4. How much sales should the entity achieve to break even?

5. Compute BEP through equation approach.
MULTI-PRODUCT/SERVICE BREAK-EVEN CALCULATIONS
NOTES FOR COMPUTING WAUCM & WACMR
• For purposes of computing the weighted average unit contribution margin, the sales mix ratio
is determined using the sales volume in units.
• For purposes of computing the weighted average contribution margin ratio, the sales mix ratio
is determined using the sales volume in pesos.
A company sells Products A, B, and C. Data about the three products are as follows:
A B C Total
Selling price P 100 P 120 P 50
Variable costs per unit 36 90 30
Contribution margin 64 30 20
Sales in units 1,500 2,000 2,500 6,000
Total fixed costs P125,000
1. Compute for the company’s break-even point in pesos.

2. Compute for the company’s break-even point in units.
GRAPHING CVP RELATIONSHIPS
REQUIRED SALES WITH DESIRED PROFIT
To earn a desired amount of profit before tax
To earn a desired amount of profit after tax

To earn a desired profit ratio (profit as a percentage of the required sales)
expenses. Fixed costs per period amounts to P750,000. The entity’s desired profit before tax
is P330,000.
1. How many units should the entity sell to achieve the target profit before tax?
2. How much sales should the entity generate to achieve the target profit before tax?
expenses. Fixed costs per period amounts to P750,000. The entity’s desired profit after tax is
P193,500. The tax rate is 25%.
1. How many units should the entity sell to achieve the target profit after tax?
2. How much sales should the entity generate to achieve the target profit after tax?
MARGIN OF SAFETY
Margin of safety measures the potential effect of the risk that the sales will fall short of planned sales,
which is the difference between actual or budgeted sales and break-even sales.
SCM Company’s budget for the coming year revealed the following data:
Budgeted net income P875,000
Variable Fixed
Manufacturing P14.00 P12.00
Selling 2.50 5.50
General 0.25 7.00
Unit selling price P50

1. Compute for the margin of safety in pesos.
2. Compute for the margin of safety ratio.
OPERATING LEVERAGE
• Operating leverage represents the relationship between the entity’s fixed costs and variable
costs.
• An entity with high fixed costs tends to have a high operating leverage, like airline
industries. Usually, its fixed costs are higher than its variable costs.
• An entity with a high operating leverage can expect net income going up when sales increase,
because fixed costs will remain the same.
• Similarly, an entity with a high operating leverage can expect net income going down when
sales decrease because it will still incur fixed costs, up until they suffer losses.
DEGREE OF OPERATING LEVERAGE
• The degree of operating leverage measures how well an entity generates profit using its
fixed costs. It is used to measure the extent of the change in profit before tax resulting from
the change in sales.
• Leverage is achieved by increasing fixed costs while lowering variable costs.
Following is the company’s result of operations from its present sales level of 10,000 units:
Sales (10,000 units @ P5) P 50,000

Variable costs (10,000 units @ P3) 30,000
Contribution margin P 20,000
Fixed costs 12,000
Profit before tax P 8,000
1. Compute for the operating leverage factor (OLF).
2. If the company’s sales would increase by 10%, by what rate would profit before tax increase?
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COST-VOLUME-PROFIT (CVP) Analysis

ELEMENTS OF CVP ANALYSIS

• Sales • Total fixed costs

• Selling price • Variable costs per unit

• Units or volume • Sales mix

Break-even point is the point (sales volume level in pesos or

Contribution margin is the difference between the entity’s

Margin of safety is the difference between actual or

Margin of safety ratio is MOS divided by the actual or budgeted

Sales mix is the combination of

KEY ASSUMPTIONS IN CVP ANALYSIS

1. All costs are classifiable as either variable or fixed.

1. How much is the contribution margin per unit?

2. What is the contribution margin ratio?

3. How many units should the entity sell to break-even?

4. How much sales should the entity achieve to break even?

MULTI-PRODUCT/SERVICE BREAK-EVEN CALCULATIONS

NOTES FOR COMPUTING WAUCM & WACMR

Selling price P 100 P 120 P 50

Variable costs per unit 36 90 30

Sales in units 1,500 2,000 2,500 6,000

Total fixed costs P125,000

1. Compute for the company’s break-even point in pesos.

REQUIRED SALES WITH DESIRED PROFIT

To earn a desired amount of profit before tax

To earn a desired amount of profit after tax

Budgeted net income P875,000

Manufacturing P14.00 P12.00

Selling 2.50 5.50

General 0.25 7.00

Unit selling price P50

2. Compute for the margin of safety ratio.

DEGREE OF OPERATING LEVERAGE

• Leverage is achieved by increasing fixed costs while lowering variable costs.

Sales (10,000 units @ P5) P 50,000

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