FIN9014M

Managerial Finance

Week 3 Lecture notes

Cost-Volume-Profit Analysis (CVP)

1
Cost-Volume-Profit Analysis (CVP)
Concerned with the impact of changes in the
volume of an organisations activities.
Provides answers to a number of questions that
are of interest to management, including:
How do costs and revenues, and therefore
profits, change in response to changes in
volume?
At what volume will we break-even?
Makes use of the ideas of marginal costing.
2
Linearity
There is an underlying assumption of linearity
within CVP.
That is to say, the following are deemed to be
constant:
total fixed costs
variable cost per unit
selling price per unit
This linearity can be demonstrated graphically
using a Breakeven Chart.
3
Breakeven Chart

Cost/
Revenue total
cost

variable cost
fixed
cost

Activity 4
Breakeven Chart

total revenue

Cost/
Revenue total
cost

breakeven point

Activity 5
Linearity
Linearity cannot exist at all levels of activity:
step costs
economies of scale- the more we
produce, the better off well be
diseconomies of scale

6
Linearity
Within the relevant range, the linearity
assumption is valid.

Other Graphical Presentations

In addition to the breakeven chart, we also
encounter the following:
contribution chart
profit-volume chart

7
Contribution Chart

total revenue

Cost/
Revenue total
cost
fixed
cost variable
cost

Activity 8
Contribution Chart

total revenue

Cost/ contribution
Revenue

breakeven
point

Activity 9
Profit-Volume Chart
Profit/Loss
Profit

0
Activity
breakeven
point
Loss
fixed cost
10
Margin of Safety-by how much production or
sales can reduce without incurring losses

total revenue

Cost/
Revenue total
cost

breakeven
point

11
Margin of Safety

Cost/ margin
Revenue of
safety

margin of
safety

12
Activity
Calculation of Breakeven Point
Total Profit = Total Revenue Total Cost
At breakeven, total profit = zero
0 = Total Revenue Total Cost
Total Revenue = Total Cost
Let Q = volume of activity
s = selling price per unit
v = variable cost per unit
F = total fixed cost
Qs = F + Qv
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Calculation of Breakeven Point
Qs = F + Qv
Qs Qv = F
Q(s-v) = F
Q= F
s-v
s-v is the contribution per unit; this gives us the
well-known formula:
Breakeven Point (units) = Fixed Costs
Contribution Per Unit
14
Calculation of Breakeven Point
Example
A company sells a single product for 5 per unit.
In the previous two months, sales (and
production) volume and total costs were as
follows:
Sales Units Total Cost
Month A 10,000 41,000
Month B 11,500 45,500
Calculate: i) the breakeven point, and
ii) the margin of safety in each month
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Calculation of Breakeven Point
Solution
Need to use High-Low to separate fixed and
variable costs.
Sales Units Total Cost
Month B 11,500 45,500
Month A 10,000 41,000
1,500 4,500
Variable cost per unit = 4,500 = 3
1,500

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Calculation of Breakeven Point
Solution
Sales Units Total Cost
Month B 11,500 45,500
Month A 10,000 41,000
1,500 4,500
Variable cost per unit = 4,500 = 3
1,500
For 10,000 units,
Total Cost = 41,000
Variable cost = 10,000 x 3 = 30,000
Fixed Cost = 11,000 17
Calculation of Breakeven Point
Solution
Selling price per unit = 5
Variable cost per unit = 3
Contribution per unit = 2
Fixed Cost = 11,000
Breakeven Point (units) = Fixed Costs
Contribution Per Unit
= 11,000 = 5,500 units
2
This equates to turnover of 5,500 x 5 = 27,50018
Calculation of Margin of Safety
MS: How much output or sales level can fall before a business
reaches its breakeven point

Solution
Month A Month B
Sales units 10,000 11,500
Breakeven point 5,500 5,500
Margin of safety (units) 4,500 6,000
Selling price per unit x 5 x 5
Margin of safety (turnover) 22,500 30,000
Margin of safety (units) 4,500 6,000
Sales units 10,000 11,500
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Margin of safety (%) 45% 52%