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Chapter 3: Cost-Volume-profit (CVP) Analysis
Cost-volume-profit analysis is a technique for evaluating the effect of changes in cost and
volume on profit. Costs include variable and fixed costs that are expenses of the period.
Volume represents the level of sales activity, either in units or in dollars. Profit for the firm
may be net income or operating income. The role of this analysis is to help managers answer
questions that relate to certain decisions. For example, given the selling price, fixed costs and
variable costs of the products, management can determine how many units must be sold to
break even – to have a net income of zero. The break-even point is that level of volume at
which the firm earns zero profit. Analyzing costs and volume in order to determine the break-
even point is referred to as break-even analysis.
Uses of CVP analysis:
CVP enables the management to reach planning and policy making decisions more
intelligently. This analysis is used in the following cases:
1. Determination of profit which will result from any given volume of sales.
2. Analysis of effect of changes in selling price.
3. Effect of changes in product mixture.
4. Additional sales volume needed to support an additional expenditure.
5. Lowest price at which business may be accepted to utilize facilities and contribute
something towards net profit.
6. The particular products to be emphasized to reflect the highest net profit.
7. Determination of unit costs at various volume levels.
8. Determination of probable effect of investment in new plant and equipment.
9. Determination of most profitable use of scarce materials.
10. Determination of how many units must be sold to earn a specific net income or a
minimum desired rate of return.
11. Determination the necessary selling price of a product, given expected volume, costs and
desired profit.
Assumptions in CVP Analysis:
1. Costs have been accurately distinguished as variable and fixed.
2. Fixed costs remain constant within the relevant range of analysis.
3. Total variable costs are affected only by changes in volume.
4. Revenues are linear
5. No change in inventory levels
6. Sales-mix is constant for multiple product firm
Techniques used in CVP analysis:
1. Equation Technique:
Sales = Fixed Costs + Variable Costs + Desired Net Income
Example- Selling price per unit Tk.30, Fixed costs Tk.200000, Variable Cost per unit Tk.15
and Desired net income Tk.80000. Determine sales in units and in amount.
Let, Sales is X units
30X = 200000 + 15X + 80000
or, 15X = 280000
or, X = 280000/15 = 18667
Sales in unit 18667 and in amount Tk.(18667*30) 560010
2. Contribution margin technique :
Break even point = Fixed Costs / Contribution margin ratio
Required sales for a desired net income = (Fixed Costs+Desired net income) / Contribution
margin ratio
Example- Selling price per unit Tk.40, Variable cost per unit Tk.25, Fixed Costs Tk.300000
and Desired net income Tk.50000.
Break-even point sales = 300000 / {(40-25)/40}
= 300000 / 0.375
= 800000
Required sales for a desired net income = (Fixed Costs + Desired net income) / Contribution
margin ratio
= (300000+50000) / {(40-25)/40}
= 350000 / 0.375
= 933333
