Concept of C-V-P Analysis

C-V-P Analysis means Cost Volume Profit Analysis

It is the Relation between Cost incurred to manufacture a product, Volume or number of units produced and Profit generated by selling the product.

Lets understand with the help of a graph

It is the graph between amount and the number of units.

You can see that there is a Fixed Cost Area and Variable Cost Area.

Fixed cost is the cost which is independent of the number of goods or services produced. For example cost incurred to buy land, machinery etc. or the rent of the place or office etc.

Variable cost is the cost which varies with the number of goods produced. For example the cost of raw material or cost of packaging etc.

Now you can also see a Total Cost Line and a Total Sales Line.

If you observe, you can see that the income or sales line starts from zero and the cost line starts from $ 1,000,000, it is because when a first product is sold then the company will start earning profit , before that there was no profit but before the company starts manufacturing the product they already have spend their fixed cost in establishing the plant and machinery.

now you see as the goods are manufactured their variable cost increase with the number of goods produced and as they are sold the income generated in increased and hence there is one point where the cost incurred becomes equal to the income generated and this point is called Break Even Point.

Break Even Point

It is the point at which there is no profit and no loss and the revenue equals the expenditure. We can see in the graph that we get two BEP points , one on X axis in terms of number of units produced to cover all the cost with income and the other on the Y axis, which shows the amount of sales required to cover all the cost incurred.  You will notice that after this point the company will start generating profit.

Red and Green shaded area

Red area is the area of loss and green area is the area of profit.

In this chapter you will find few formulas , so let me revise few concepts and correlate them with the new concept.

So, lets recall the income statement format.

Sales

- Variable cost (also called Marginal cost)

-------------------------------------------------

Contribution

- Fixed cost

-----------------------------

EBIT ( Earning before Interest and tax)

- Interest

-----------------------------

EBT  (Earnings before tax)

Just remember this format as this will help you in deriving the unknown figures from the known ones.

Here we will study the relation between profit and volume of sales known as P/V Ratio.

P/V Ratio  (%) = Contribution * 100

                                       Sales

If the income statement of two different years is given then

P/V Ratio  (%) =  Change in contribution * 100

                                       Change in Sales

Now another concept which we must know is concept of BEP or  Break Even Point. As we have already discussed while discussing the graph that we will get two BEP points one on X axis (in terms of Number of units produced and another on Y axis ( in terms of Amount of sales)

BEP (in units) =              Fixed cost       

                            Contribution per unit

BEP (in amount) =              Fixed cost       

                                             P/V Ratio

In the next concept we will learn to find out how much Sales has to be done to earn the desired profit. For example , we decide that this year we decide to earn a profit of $1,000,000 , now we will have to find out the amount of sales to be done to earn this amount as profit. For this we will apply the following :-

Sales to earn desired profit (in units) =    Fixed cost + Desired profit  

                                                                   Contribution per unit

Sales to earn desired profit (in amount) = Fixed cost + Desired profit 

                                                                               P/V Ratio

Last concept of this chapter is MOS ( Margin of Safety)

MOS = Actual Sales - BEP Sales

Its the time for you to revise all the above concepts and get prepared for the Numerical problems.