Tutorial 3a Cost-Volume-Profit Analysis

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1 Tutorial 3a Cost-Volume-Profit Analysis J. E. Cairnes School of Business and Economics NUI Galway Cost-Volume-Profit (CVP) Analysis This is a method used to examine the relationship between changes in volume/output and changes in total sales revenue, expenses and net profit CVP analysis enables management to identify critical output levels, such as the level at which profit will be maximised or break-even point (the level at which neither a profit or loss will occur) Based on the short run; one year or less Cost- Volume-Profit Analysis Need to analyse the behaviour of costs in relation to changes in volume Classification of costs into fixed and variable NUI Galway 1

2 Fixed Costs -> Fixed costs remain the same i.e. fixed irrespective of the level of activity or volume of output E.g. Rent, insurance, cleaning costs, depreciation Volume Variable Costs -> varies directly with changes in the level of output e.g. raw material costs = 8 per unit of output produced Volume Step Fixed Costs- A cost which is fixed over a certain range of production (quantity) but then increases as the capacity (and the usage of a particular activity) increases Volume NUI Galway 2

3 Semi-variable Cost-A cost which is partially fixed and partially varies with the changes in the level of quantity (activity) e.g: telephone costs; fixed line rental plus costs for the calls Cost The slope of this line is the variable cost per unit Volume Variable cost element Fixed cost element 7 CVP Analysis Y = a + bx Total Cost Sales = Fixed Costs + Variable x Costs Less Variable Costs (x) Contribution x Less Fixed Costs (x) Profit x Contribution Contribution = Sales Revenue less Variable costs Contribution/ unit (CPU)= Sales price/unit- Var cost/unit Indicates revenue remaining after all variable costs have been covered Variable costs include variable production and variable selling and administration costs NUI Galway 3

4 Break-even point (BEP) At break-even point total costs = total revenues i.e. no profit or loss is made Where: Sales Less Variable Costs Contribution Less Fixed Costs x (x) x (x) 0 Break-even Point To calculate breakeven point in units: Total fixed costs Contribution per unit Example 1 Sales price per unit = 100 Variable cost per unit = 40 Fixed Costs = 6,000 What is Contribution per unit? What Contribution is required to breakeven? How many units need to be sold to breakeven? NUI Galway 4

5 What is Contribution per unit? Sales price per unit 100 Less variable cost per unit 40 Contribution per unit 60 What Contribution is required to breakeven? At the break-even point no profit or loss is made i.e. Sales Variable costs= Fixed costs The fixed costs are 6,000 For no profit or loss contribution needs to be 6,000 How many units that need to be sold to breakeven? Total Fixed Costs Contribution per unit = 6, = 100 units (required to be produced to breakeven) NUI Galway 5

6 Target Profit Sales required to earn target profit in units: Total fixed costs + Target profit Contribution per unit Example 2 Sales price per unit = 100 Variable cost per unit = 40 Fixed Costs = 6,000 Q- What production is required to generate a profit of 30,000? ( 6, ,000) = 600 units 60 Margin of Safety (MOS) The excess of a company s budgeted or actual units or revenues over its BEP Reflects the amount by which sales can drop before reaching BEP Margin of safety (units)= Actual units Breakeven units Or as a percentage Actual units Breakeven units = % Actual units NUI Galway 6

7 CVP Assumptions Fixed costs remain fixed regardless of the level of activity Variable costs are the same at all levels of activity No changes in stock levels everything that is produced is sold Sales Price will be the same at all output levels There is no uncertainty in the estimates of fixed and variable costs Breakeven Chart Sales Breakeven point Profit Total cost 0 Loss Volume units/ s Total fixed cost Let s look at some CVP examples In Tutorial 3b we will look at Leaving Cert Ordinary Level 2010 Q8 In Tutorial 3c we will look at Leaving Cert Ordinary Level 2012 Q8 In Tutorial 3d we will look at Leaving Cert Higher Level 2011 Q8 See: for tutorials on other topics NUI Galway 7

8 Interested in pursuing an accounting career? Study at NUI Galway CAO Course Codes GY201 B Comm GY202 B Comm (International) with French GY203 B Comm (International) with German GY204 B Comm (International) with Spanish GY207 B Comm (Accounting) GY208 B Comm (Gaeilge) For further information NUI Galway 8

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