COST-VOLUME-PROFIT ANALYSIS

COST-VOLUME-PROFIT ANALYSIS

Cost-volume-profit (CVP) analysis is a technique that examines changes in profits in response to changes in sales volumes, costs, and prices. Accountants often perform CVP analysis to plan future levels of operating activity and provide information about:

_ Which products or services to emphasize

_ The volume of sales needed to achieve a targeted level of profit

_ The amount of revenue required to avoid losses

_ Whether to increase fixed costs

_ How much to budget for discretionary expenditures

_ Whether fixed costs expose the organization to an unacceptable level of risk

The following assumptions are to be taken into consideration while performing this analysis.

·         Sales price per unit is constant.

·         Variable costs per unit are constant.

·         Total fixed costs are constant.

·         Everything produced is sold.

·         Costs are only affected because activity changes.

·         If a company sells more than one product, they are sold in the same mix.

Cost-volume-profit analysis (CVP), or break-even analysis, is used to compute the volume level at which total revenues are equal to total costs. When total costs and total revenues are equal, the business organization is said to be "breaking even." The analysis is based on a set of linear equations for a straight line and the separation of variable and fixed costs.

Total variable costs are considered to be those costs that vary as the production volume changes. In a factory, production volume is considered to be the number of units produced, but in a governmental organization with no assembly process, the units produced might refer, for example, to the number of welfare cases processed.
There are a number of costs that vary or change, but if the variation is not due to volume changes, it is not considered to be a variable cost. Examples of variable costs are direct materials and direct labor. Total fixed costs do not vary as volume levels change within the relevant range. Examples of fixed costs are straight-line depreciation and annual insurance charges.
Total cost = total fixed cost + total variable cost
Total variable cost is calculated by multiplying the cost of a unit, which remains constant on a per-unit basis, by the number of units produce

Sales – Variable Cost = Contribution = Fixed Cost + Profit

P/V (profit – volume) ratio = Contribution/Sales

Break Even Point(in units) =        Fixed Cost

                                                Contribution per unit 

Break Even Point (volume) =         Fixed Cost

                                                         P/V ratio

Targeted Sales for a given profit figure

Sales = F.C.+Desired Profit

                                                P/V ratio

Margin of safety (MOS) is the excess of budgeted or actual sales over the break even volume of sales. It stats the amount by which sales can drop before losses begin to be incurred. The higher the Margin of safety, the lower the risk of not breaking even.

Formula of Margin of Safety:

The formula or equation for the calculation of margin of safety is as follows:

[Margin of Safety = Total budgeted or actual sales − Break even sales]

The margin of safety can also be expressed in percentage form. This percentage is obtained by dividing the margin of safety in dollar terms by total sales. Following equation is used for this purpose.

[Margin of Safety = Margin of safety in Rs. / Total budgeted or actual sales]