CVP Analysis Lecture Notes PDF

COST VOLUME PROFIT ANALYSIS  Variable Costs A cost that varies directly with changes in the level of activity, over a defined period of time  VARIABLE COSTS TOTAL VARIABLE COST COSTS € VOL...

COST VOLUME PROFIT ANALYSIS  Variable Costs A cost that varies directly with changes in the level of activity, over a defined period of time  VARIABLE COSTS TOTAL VARIABLE COST COSTS € VOLUME OF ACTIVITY VARIABLE COST PER UNIT COST PER UNIT COST € VOLUME OF ACTIVITY  Fixed Costs A fixed cost is one which is not affected by the changes in the level of activity, over a defined period  FIXED COSTS TOTAL FIXED COSTS COST € VOLUME OF ACTIVITY  FIXED COST PER UNIT COST PER UNIT COST € VOLUME OF ACTIVITY  TOTAL COST VARIABLE COSTS COST € FIXED COSTS VOLUME OF ACTIVITY  CONTRIBUTION Contribution is defined as the selling price of goods less the variable costs involved in making those goods. Another way of putting it is that it represents the contribution towards the fixed costs. 9 CONTRIBUTION MARGIN CONTRIBUTION MARGIN PER HANDBAG Revenue €80 - Variable Costs €50 Contribution Margin €30 CONTRIBUTION PER UNIT Selling Price - Variable Costs = Contribution Per Unit 12  BREAK EVEN POINT Revenue = Costs The idea of break-even point is very useful for a business, as they will know that any sales in excess of this point will generate profit for the business 13  BREAK EVEN POINT Formula: Fixed Costs. Contribution per unit 14  EXAMPLE : BREAK EVEN POINT The fixed costs of the business are €60,000. The selling price of Product A is €9 and the variable costs which comprise materials, labour and variable overheads amount to €5 per unit. Calculate the break even point in units and in €. 15 MARGIN OF SAFETY The difference in units between the budgeted expected sales volume and the break-even sales volume. It shows by how much sales can fall before the business will make a loss. 16  MARGIN OF SAFETY % Formula: Budgeted Sales – BEP x 100 = % Budgeted Sales 17  EXAMPLE Aran Ltd. produces a product which has a variable cost of €28 and a selling price of €39. Budgeted sales and production volumes for the next month are 18,000 units. Budgeted fixed costs are €121,000 per month. Requirement: (a) Calculate the break-even point (b) Calculate the margin of safety and margin of safety ratio 18  TARGET PROFIT Formula: Fixed Costs + Target Profit. Contribution per unit 19  EXAMPLE Arlo Ltd manufactures a single product. The budgeted sales volume for the next year is 275,000 units. Total cost per unit is €16 which includes €3 of fixed costs. Each unit sells for €25. Requirements: 1) The break-even point 2) The margin of safety in units and the margin of safety ratio. 3) The number of units which must be sold to achieve a profit of €100,000 20  RELEVANT RANGE Within relevant range, elements of cost are presumed to behave in a linear fashion VC/u (constant %) FC (straight line) So Total Cost is straight line sloping diagonally upwards How does this relate to reality? Probably reasonably well within relevant range, as we are making no claims about what happens outside that range 21  RELEVANT RANGE In long term, business may expand its capacity, move to different level of fixed costs Move to larger premises Buy more machinery etc Often in the short term business is effectively restricted by capacity so CVP analysis use of relevant range reflects practical constraint Reflects choice made by company about possible level of operations 22 RELEVANT RANGE 23