Cost volume profit analysis

The Cost-Volume-Profit(C-V-P) analysis is the analysis of the cost evolution models, which point out the relation between cost, production volume and profit. The C-V-P analysis is a useful forecasting as well as managerial control tool. This analysis technique expresses the relation between income, sales structure, costs, production volume and profits and includes break-even point analysis and profit forecasting procedure. These relations may be used by managers to make short term forecasts, to assess company performance and to analyze decision making alternatives. Cost volume profit analysis of three variables i.e. cost volume and profit.

This analysis measures variation of cost volumes and their impact on profit is affected by several internal and external factors which influences sales revenue and costs. Cost volume profit analysis helps the management in profit planning. Profit of a concern can be increase by increasing the output and sales or reducing cost. If a concern produces to maximum capacity and sell, contribution is also increased to maximum level. The cost volume profit analysis is attempted to measure the effect of changes in volume, cost, price and product mix on profit. With increase in volume units costs of production decrease and vice versa, because the fixed costs are constant. With decrease in fixed cost per unit profit will be more. Cost volume profit analysis is made with the objective of ascertaining the following The cost for various level of product.

The desire volume of production. The profit at various level of production. The difference between sales revenue and variable cost. Cost volume profit analysis is a logical extension of marginal costing. It is based on the same principles of classifying the operating expenses into fixed and variable. Now an it has become a powerful instrument in the hands of policy makers to maximize profit. There may be change in the level of production due to many reasons, such as competition, introduction of new product, trade depression or boom, increased demand for the products, and changes in selling prices of the changing levels of production.

A number of techniques can be used as an aid to management in this respect. One such technique is the break even analysis. The term cost volume profit analysis is the narrower as well as broader sense. Used in its narrower sense, it is concerned with finding out the breakeven point; i.e. level of activity where the total cost equals total selling price. Used in its broader sense, it means that system analysis which determines the probable profit at any level of production. The break even analysis establishes the relationship of cost volume and profit; so this analysis is known as “Cost Volume Profit analysis”.

 Marginal Costing

Marginal costing is defined by IMA London as “The ascertainment of marginal cost, by differentiating between fixed and variable costs, and of the effect on profit of changes in volume or type of output”. This definition makes it clear that marginal costing goes beyond the ascertainment of costs. It is a technique concerned with the effect on profit when the volume or type of output changes. In particular, marginal costing studies the effect which fixed cost has on the running of business.

Break Even Point: The BEP is the volume of output at which total costs is exactly equal to revenue. It is a point of no profit and no loss. This is the minimum point of production as which total cost is recovered and after this point profit begins.

B.E.P = F / (S - V) Where: B.E.P = Break-even point (units of production), F = Total Fixed costs, V =Variable costs per unit of production, S =Savings or additional returns per unit of production, and the mathematical approach is best presented using examples.

Fixed cost B.E.P (unit) = ------------------------------------------------------------ Selling price per unit – marginal cost per unit.

(a) In term Of Value

B.E.P = Fixed cost * Sales Contribution

(Or) B.E.P = Fixed cost P/V ratio

(b) In term Of Units

B.E.P = Fixed cost Contribution per unit

1.1.3. Required Sales

(a) In term Of Values

= Fixed Cost + Required Profit P/V Ratio

(b) In Term of Unit

= Fixed Cost + Required Profit Contribution per Unit

1.1.4. Profit volume ratio

The profit / volume ratio, better known as contribution / sales ratio (C/S ratio), expresses the relation of contribution to sales.

P/V ratio = Contribution * 100 Sales

(Or) P/V ratio = Fixed cost + Profit *100 Sales 1.1.5. Margin of Safety Margin of safety may be defined as the difference between actual sales and sales at breakeven point.

(a) M/S = Actual Sales – B.E.P

(b) M/S = Profit P/V Ratio 1.1.6. Contribution Contribution is the difference between sales and the marginal cost of sales. It is also known as contribution margin or gross margin.

Contribution = Sales – Variable cost

Contribution = Fixed cost + Net Profit

Contribution = Fixed cost – Net Loss

Contribution = Sales * P/V Ratio

1.1.7. Contribution per Unit

Contribution per Unit = Sales per Unit – Variable Cost per Unit.

Literature Review 1. Li Tak Ming, Andy Deputy Head, Department of Business Administration, Hong Kong Institute of Vocational Education Title: A Cost- Volume- Profit Analysis Cost volume profit analysis is the study of effects on future profit of change in fixed cost, variable cost, sales prices, quantity. It ia also known as break even analysis. Cost volume profit is useful management tool used by planner in determining the amount of sales needed to cover all expenses. 2. Wei Shih Title: A general Decision model for cost volume profit analysis under uncertainty. This paper presents a general decision for cost volume analysis which takes into account the crucial element of random demand and level of production in the determination of actual sales and resulting profit. 3. Dr. Mode Shubita Title: usefulness of cost volume analysis as a managerial concept. In order to cope with planning decision manager use cost volume profit analysis. They find it an extremely useful measurement in a variety of ways. This paper aimed to increase the understanding usefulness of cost volume profit concept. 4. Karen s. Hreha and Wondy M. Liao College of commerce and Business administration, University of Illionois at Urbana champaign. The tradition CVP analysis has been extended to consider the effect of learning. Learning effect have a significant impact on CVP analysis, they not only change the traditional breakeven point, but also affect the distribution of profit. This paper demonstrates the effect of learning on cost volume profit analysis and develops a cost volume profit model with consideration given to both single and probilistic learning rate estimates.