Description
This is a presentation describes volume cost profit analysis with help of detailed examples.
Volume-Cost-Profit Analysis
16-1
VOLUME-COST-PROFIT ANALYSIS
BREAK-EVEN ANALYSIS
16-2
Volume-Cost-Profit Analysis
The cost-volume-profit (CVP) analysis is a tool to show the relationship between various ingredients of profit planning, namely, unit sales price (SP), unit variable cost (VC), fixed costs (FC), sales volume, and sales-mix (in the case of multi-product firms).
The crucial step in this analysis is the determination of break-even point (BEP), which is defined as the sales level at which the total revenues equal total costs. It is the level at which losses cease and beyond which profit starts.
16-3
Break-Even Point
BEP can be determined by the following two methods (1) Algebraic Methods (2) Graphic Presentation a) Contribution margin a) Break-even chart approach b) Equation technique b) Volume-profit graph
16-4
1(a) Contribution Margin Approach
Contribution margin is the excess of unit sale price over unit variable cost Example 1: “How many ice-creams, having a unit cost of Rs 2 and a selling price of Rs 3, must a vendor sell in a fair to recover the Rs 800 fees paid by him for getting a selling stall and additional cost of Rs 400 to install the stall?” The answer can be determined by dividing the fixed cost by the difference between the selling price (Rs 3) and cost price (Rs 2). Thus BEP (units) = Fixed cost (Entry fees + Stall expenses) (Sales price – Unit variable cost) Fixed costs Contribution margin (CM) per unit
(Rs 800 + Rs 400)/(Rs 3 – Rs 2) = 1,200 units BEP (units) =
BEP (amount)/BEP (Sales revenue)/BESR = BEP (units) × Selling price (SP) per unit = 1,200 × Rs 3 = Rs 3,600
16-5
BEP (amount) =
Fixed costs Profit volume ratio (P/V ratio) Contribution margin per unit Selling price per unit
P/V ratio =
BEP (amount)
= Rs 1,200 † 0.3333 = Rs 3,600
From the P/V ratio, the variable cost to volume ratio (V/V ratio) can be easily derived: V/V ratio = 1 – P/V ratio
In the vendor?s case, it is = 1–1/3 = 2/3 = 66.67 per cent
The V/V ratio, as the name suggests, establishes the relationship between variable costs (VC) and sales volume in amount. The direct method of its computation is: Variable cost Sales revenue
= Rs 2 † Rs 3 = 66.67 per cent
Thus, P/V ratio + V/V ratio = 1 or 100 per cent (1/3 + 2/3) = 1 (33.33 per cent + 66.67 per cent) = 100 per cent
16-6
Margin of Safety Margin of safety is the excess of actual sales revenue over the break-even sales revenue.
The excess of the actual sales revenue (ASR) over the break-even sales revenue (BESR) is known as the margin of safety. Symbolically, margin of safety = (ASR – BESR) When the margin of safety (amount) is divided by the actual sales (amount), the margin of safety ratio (M/S ratio) is obtained. Symbolically, M/S ratio = (ASR – BESR)/ASR Assume in the vendor?s case that sales is 2,000 units (Rs 6,000); margin of safety (Rs 6,000 – Rs 3,600) = Rs 2,400; and the M/S ratio is Rs 2,400 ÷ Rs 6,000 = 40 per cent. The amount of profit can be directly determined with reference to the margin of safety and P/V ratio. Symbolically, Profit = [Margin of safety (amount)] × P/V ratio Or Profit = [Margin of safety (units) × CM per unit] In the vendor?s case, profit = Rs 2,400 × 0.3333 (33.33 per cent) = Rs 800 or 800 × Re 1 = Rs 800. The reason is that once the total amount of fixed costs has been recovered, profits will increase by the difference of sales revenue and variable costs.
16-7
1( b) Equation technique
The equation technique is particularly useful in situations where unit price and unit variable costs are not clearly defined. The excess of actual sales over the BE sales is the margin of safety. When margin of safety is divided by the actual sales, we get margin of safety ratio which indicates the percentage by which actual sales may decline without causing any loss to the firm
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Sales revenue-Total costs = Net profit Breaking up total costs into fixed and variable, Sales revenue – Fixed costs – Variable costs= Net profit. Or Sales revenue = Fixed costs + Variable costs + Net profit. If S be the number of units required for break-even and sales revenue (SP) and variable costs (VC) are on per unit basis, the above equation can be written as follows: SP (S) = FC + VC (S) + NI Where SP = Selling price per unit S= Number of units required to be sold to break-even FC= Total fixed costs VC= Variable costs per unit NI= Net income (zero) SP (S)= FC + VC (S) + zero
SP (S) – VC (S)= FC
16-9
Example 2
SV Ltd, a multi-product company, furnishes you the following data relating to the current year:
Particulars Sales Total costs First half of the year Rs 45,000 40,000 Second half of the year Rs 50,000 43,000
Assuming that there is no change in prices and variable costs and that the fixed expenses are incurred equally in the two half-year periods, calculate for the year:
(i)The profit-volume ratio, (ii) Fixed expenses, (iii) Break-even sales, and (iv) Percentage margin of safety.
Solution Sales revenue – Total costs = Net profit Rs 45,000 – Rs 40,000 = Rs 5,000 (first half) Rs 50,000 – Rs 43,000 = Rs 7,000 (second half) On a differential basis: ? Sales revenue, Rs 5,000 – ? Total costs, Rs 3,000 = ? Total profit, Rs 2,000.
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We know that only VC changes with a change in sales volume and, hence, change in total costs are equivalent to VC (Rs 3,000). Accordingly, the additional sales of Rs 5,000 has earned a contribution margin of Rs 2,000 [Rs 5,000 (S) – Rs 3,000 (VC)]. P/V ratio V/V ratio = Rs 2,000 ÷ Rs 5,000 = 40 per cent. = 100 per cent – 40 per cent = 60 per cent.
Accordingly, 60 per cent of the total costs are made up of variable costs and the balance represents the total fixed costs (FC). Sales revenue = Fixed costs + Variable costs + Net profit Rs 95,000 = FC + 0.60 × (Rs 95,000) + Rs 12,000 Rs 95,000 = FC + Rs 57,000 + Rs 12,000
Rs 95,000 – Rs 69,000 = FC or Rs 26,000 = FC
BEP (amount) = Rs 26,000 ÷ 0.40 = Rs 65,000
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Verification Particulars Break-even sales Variable costs Contribution Fixed costs Net income Amount Rs 65,000 39,000 26,000 26,000 Nil Per cent 100 60 40 40 Nil
M/S ratio =
(Rs 95,000 – Rs 65,000
Rs 95,000
= 31.58%
16-12
Break-Even Application
Sales Volume Required to Produce Desired Operating Profit
(Fixed expenses + Desired operating profit) † P/V ratio
In Example 2, if the desired operating profit of SV Ltd is Rs 14,000, required sales volume = (Rs 26,000 + Rs 14,000)/0.40 = Rs 1,00,000 Operating Profit at a Given Level of Sales Volume
[Actual Sales Revenue (ASR) – Break-even Sales Revenue (BESR)] × P/V ratio
Effect on Operating Profit of a Given Increase in Sales Volume [Budgeted Sales Revenue (BSR) – BESR] × P/V ratio
Suppose that SV Ltd forecasts 10 per cent increase in sales next year, the projected profit will be: (Rs 1,04,500 – Rs 65,000) × 0.40 = Rs 15,800
16-13
Additional Sales Volume Required to Offset a Reduction in Selling Price Suppose that SV Ltd reduces its selling price from Rs 10 a unit to Rs 9. The sales volume needed to offset reduced selling price/maintain a present operating profit of Rs 12,000 would be:
Desired profit (P) + Fixed expenses (FC) = Rs (12,000 + Rs 26,000) † 0.3333 = Rs 1,14,000 Revised P/V ratio (Rs 3/Rs 9)
The required sales volume of Rs 1,14,000 represents an increase of about 20 per cent over the present level. The management should explore new avenues of sales potential to maintain the existing amount of profit
16-14
Effect of Changes in Fixed Costs A firm may be confronted with the situation of increasing fixed costs. An increase in the total budgeted fixed costs of a firm may be necessitated either by external factors, such as, an increase in property taxes, insurance rates, factory rent, and so on, or by a managerial decision of an increase in salaries of executives. More important than this in the latter category are expansion of the present plant capacity so as to cope with additional demand. The increase in the requirements of fixed costs would imply the computation of the following: (a) Relative break-even points. (b) Required sales volume to earn the present profits. (c) Required sales volume to earn the same rate of profit on the proposed expansion programme as on the existing ones. The effect of the increased FCs will be to raise the BEP of the firm. Assume the management of SV Ltd decides a major expansion programme of its existing production capacity. It is estimated that it will result in extra fixed costs of Rs 8,000 on advertisement to boost sales volume and another Rs 16,000 on account of new plant facility.
16-15
Multi-product Firms (Sales-mix) Example 3 The Garware Paints Ltd presents to you the following income statement in a condensed form for the first quarter ending March 31: Particulars Sales Variable costs Contribution Fixed costs Net income P/V ratio Break-even sales Sales-mix (per cent) Product X Rs 1,00,000 80,000 20,000 Y Rs 60,000 42,000 18,000 Z Rs 40,000 Rs 2,00,000 24,000 1,46,000 16,000 54,000 27,000 27,000 0.40 0.27 1,00,000 0.20 100 Total
0.20 0.50
0.30 0.30
If Rs 40,000 of the sales shown for Product X could be shifted equally to products Y and Z, the profit and the BEP would change as shown in Table 2.
16-16
Table 2 Break-even Point Particulars Sales Less: Variable costs Contribution Less: Fixed costs Net income P/V ratio BE sales Sales-mix (per cent) Product X Y Z Rs 60,000 Rs 2,00,000 36,000 1,40,000 24,000 60,000 27,000 33,000 0.40 0.30 90,000 0.30 100 Rs 60,000 Rs 80,000 48,000 56,000 12,000 24,000 Total
0.20 0.30
0.30 0.40
Example 3 shows that by increasing the mix of high P/V products (Y from 30 to 40 per cent, Z from 20 to 30 per cent) and decreasing the mix of a low P/V product (X from 50 to 30 per cent), the company can increase its overall profitability. In fact, it can further augment its total profits, if it can make, and the market can absorb, more quantities of Y and Z, say Rs 1 lakh each (Table 3).
16-17
Table 3 Particulars Sales Less: Variable costs Contribution Less: Fixed costs Net income P/V ratio BE sales Sales-mix (per cent) Product Y Rs 1,00,000 70,000 30,000 Z Rs 1,00,000 60,000 40,000 Rs 2,00,000 1,30,000 70,000 27,000 43,000 0.35 77,143 100 Total
0.30 0.50
0.40 0.50
From the above, it can be generalised that, other things being equal, management should stress products with higher contribution margins. For individual product line income statements, fixed costs should not be allocated or apportioned.
16-18
2(a) Break-Even Chart
The break-even chart is a graphic presentation of the relationship between costs, profits, and sales. It shows not only the break-even sales but also the estimated costs and profit at various levels of the sales revenue. It is, therefore, also referred to as volume-cost-profit (VCP) graph/chart
Assumptions Regarding the VCP Graph are
1. Costs can be bifurcated into variable and fixed components. 2. Fixed costs will remain constant during the relevant volume range of graph. 3. Variable cost per unit will remain constant during the relevant volume range of graph. 4. Selling price per unit will remain constant irrespective of the quantity sold within the relevant range of the graph. 5. In the case of multi-product companies, in addition to the above four assumptions, it is assumed that the sales-mix remains constant. 6. Finally, production and sales volumes are equal.
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Example 4
Selling price per unit Fixed costs Variable costs per unit Relevant range (units) : Lower limit : Upper limit Break-up of variable costs per unit: Direct material Direct labour Direct expenses Selling expenses Actual sales, 18,000 units (Rs 1,80,000) Plant capacity, 20,000 units (Rs 2,00,000) Tax rate, 50 per cent Rs 10 60,000 5 6,000 20,000 Rs 2 1.50 1 0.50
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Y 200 Revenue and costs (in „000 rupees) 180 160
Relevant range
Variable cost area 140 120 100 80 60 40 20 0
0 4 6 8 12 16 18 20 24 Sales volume (in thousand units) Rs 120 Rs 180 Rs 240 Sales revenue (in thousand units) 40% 60% 80% Per cent of plant capacity 28 30 Rs 300 100%
BEP Margin of safety (units) Fixed cost line
Fixed cost line X
Or Rs 60 20%
Figure 1: Volume-Cost-Profit Graph (Traditional)
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Figure 1 has been drawn by using a sales line and a total cost line (including both fixed and variable costs). The steps involved in drawing the VCP graph are enumerated as follows: 1. Select an appropriate scale for sales volume on the horizontal axis, say, 2,000 units (Rs 20,000) per square, and plot the point for total sales revenues at relevant volume: 6,000 units × Rs 10 = Rs 60,000. Draw the sales line from the origin to Rs 2,00,000 (the upper limit of the relevant range). Ensure that all the points, 0, Rs 60,000 and Rs 2,00,000 fall in the same line. This should be ensured for the total cost line also. 2. Select an appropriate scale for costs and sales revenues on the vertical axis, say, Rs 10,000 per square. Draw the line showing Rs 60,000 fixed cost parallel to the horizontal axis.
3. Determine the variable portion of costs at two volumes of scales (beginning and ending): 6,000 units × Rs 5 = Rs 30,000; 20,000 units × Rs 5 = Rs 1,00,000.
4. Variable costs are to be added to fixed costs (Rs 30,000 + Rs 60,000 = Rs 90,000). Plot the point at 6,000 units sales volume and Rs 1,00,000 + Rs 60,000 = Rs 1,60,000. Point is to be plotted at 20,000 units sales volume. This obviously is the total cost line. 5. The point of intersection of the total cost line and sales line is the BEP. To the right of BEP, there is a profit area and to the left of it, there is a loss area. 6. Verification: FC ÷ CM per unit = Rs 60,000 ÷ Rs 5 per unit = 12,000 units or Rs 1,20,000
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Figure 1 has been drawn using different scales for the horizontal and vertical axis. Figure 2 has been drawn on a uniform scale for both axes. Since the scales are the same, the 45° line will always be the proxy of the sales line. Any amount of sales revenue on the horizontal axis will correspond to costs and revenue on the vertical axis. Let us illustrate taking two sales levels.
1. Rs 60,000: FC = Rs 60,000 VC = 30,000 (50 per cent variable cost to volume ratio) TC = 90,000 Loss = 30,000 (TC, Rs 90,000 – Rs 30,000, sales revenue) Thus, Rs 60,000 = Rs 60,000 + Rs 30,000 – Rs 30,000. Point A in Figure 2 clearly shows these three relevant figures at the sales volume of Rs 60,000.
2. Rs 1,80,000: FC = Rs 60,000 VC = 90,000 TC = 1,50,000 Profit = 30,000 Thus, Rs 1,80,000 = Rs 60,000 (FC) + Rs 90,000 (VC) + Rs 30,000 (Profit). Point B in Figure 2 portrays these three relevant figures at the sales volume of Rs 1,80,000.
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Y 240
Revenue and costs (in „000 rupees)
200
160 120 BEP
80
Fixed cost line
40
0 40 0 60 80 120 140 160 180 200 240
X
Sales revenue (in „000 rupees)
Figure 2: Volume-Cost-Profit Graph, Same Scale
16-24
The VCP graph in Figure 3 is drawn with the details of the individual segment of variable cost and is more informative. The steps involved in drawing the graph include an additional step of adding variable costs to the fixed cost. This is to be repeated four times for four different components: material, labour, direct expenses and selling expenses. In fact, fixed costs can also be further split-up into parts. Such a graph provides a bird?s-eye view of the entire cost structure to the management. By drawing a line perpendicular from any volume (horizontal axis), the corresponding cost and profit variables can be ascertained on the vertical axis. For instance, at 20,000 unit level, following are the various cost figures, as shown by the VCP graph (line A). Fixed costs Variable costs: Material Labour Direct expenses Selling expenses Profit before taxes Rs 60,000 40,000 30,000 20,000 10,000 40,000
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Y 200
Rs 20,000 Net income Income tax
Selling expenses
Revenue and costs (in „000 rupees)
160 BEP 120
Rs 20,000
Rs 10,000
Variable costs & expenses
Rs 20,000
Direct expenses Direct labour cost
Total costs and expenses
Rs 30,000
80
Rs 40,000
Direct material cost
40
Rs 60,000
Fixed expenses (Factory, administration, selling)
X
4
8
12
16
20
Sales Volume (in thousand units)
Figure 3: Volume-Cost-Profit Graph, Cost-Wise
16-26
The VCP graph can be modified to show the changes in the profitability factors of Example 4, such as, 1.Change in fixed costs (Rs 10,000 both ways) 2.Change in variable costs (20 per cent both ways) 3.Change in selling price (25 per cent both ways). Table 4 provides a summary of the results due to the above changes. Only one change is taken at a point of time.
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Table 4 Variable Fixed costs (Rs 10,000): Increase Decrease (Figure 4) Variable costs: Increase (to 60 per cent) Decrease (to 40 per cent) (Figure 5) Selling price (25 per cent): Increase Decrease (Figure 6) Effect on BEP Increase (Rs 20,000) Decrease (Rs 20,000) Margin of safety Decrease (Rs 20,000) Increase (Rs 20,000) Operating profit Decrease (Rs 10,000) Increase (Rs 10,000)
Increase (Rs 30,000) Decrease (Rs 20,000)
Decrease (Rs 30,000) Increase (Rs 20,000)
Decrease (Rs 18,000) Increase (Rs 18,000)
Decrease (Rs 20,000) Increase (Rs 60,000)
Increase (Rs 20,000) Increase (Rs 60,000)
Increase (Rs 18,000) Decrease (Rs 30,000)
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doc_580641624.pptx
This is a presentation describes volume cost profit analysis with help of detailed examples.
Volume-Cost-Profit Analysis
16-1
VOLUME-COST-PROFIT ANALYSIS
BREAK-EVEN ANALYSIS
16-2
Volume-Cost-Profit Analysis
The cost-volume-profit (CVP) analysis is a tool to show the relationship between various ingredients of profit planning, namely, unit sales price (SP), unit variable cost (VC), fixed costs (FC), sales volume, and sales-mix (in the case of multi-product firms).
The crucial step in this analysis is the determination of break-even point (BEP), which is defined as the sales level at which the total revenues equal total costs. It is the level at which losses cease and beyond which profit starts.
16-3
Break-Even Point
BEP can be determined by the following two methods (1) Algebraic Methods (2) Graphic Presentation a) Contribution margin a) Break-even chart approach b) Equation technique b) Volume-profit graph
16-4
1(a) Contribution Margin Approach
Contribution margin is the excess of unit sale price over unit variable cost Example 1: “How many ice-creams, having a unit cost of Rs 2 and a selling price of Rs 3, must a vendor sell in a fair to recover the Rs 800 fees paid by him for getting a selling stall and additional cost of Rs 400 to install the stall?” The answer can be determined by dividing the fixed cost by the difference between the selling price (Rs 3) and cost price (Rs 2). Thus BEP (units) = Fixed cost (Entry fees + Stall expenses) (Sales price – Unit variable cost) Fixed costs Contribution margin (CM) per unit
(Rs 800 + Rs 400)/(Rs 3 – Rs 2) = 1,200 units BEP (units) =
BEP (amount)/BEP (Sales revenue)/BESR = BEP (units) × Selling price (SP) per unit = 1,200 × Rs 3 = Rs 3,600
16-5
BEP (amount) =
Fixed costs Profit volume ratio (P/V ratio) Contribution margin per unit Selling price per unit
P/V ratio =
BEP (amount)
= Rs 1,200 † 0.3333 = Rs 3,600
From the P/V ratio, the variable cost to volume ratio (V/V ratio) can be easily derived: V/V ratio = 1 – P/V ratio
In the vendor?s case, it is = 1–1/3 = 2/3 = 66.67 per cent
The V/V ratio, as the name suggests, establishes the relationship between variable costs (VC) and sales volume in amount. The direct method of its computation is: Variable cost Sales revenue
= Rs 2 † Rs 3 = 66.67 per cent
Thus, P/V ratio + V/V ratio = 1 or 100 per cent (1/3 + 2/3) = 1 (33.33 per cent + 66.67 per cent) = 100 per cent
16-6
Margin of Safety Margin of safety is the excess of actual sales revenue over the break-even sales revenue.
The excess of the actual sales revenue (ASR) over the break-even sales revenue (BESR) is known as the margin of safety. Symbolically, margin of safety = (ASR – BESR) When the margin of safety (amount) is divided by the actual sales (amount), the margin of safety ratio (M/S ratio) is obtained. Symbolically, M/S ratio = (ASR – BESR)/ASR Assume in the vendor?s case that sales is 2,000 units (Rs 6,000); margin of safety (Rs 6,000 – Rs 3,600) = Rs 2,400; and the M/S ratio is Rs 2,400 ÷ Rs 6,000 = 40 per cent. The amount of profit can be directly determined with reference to the margin of safety and P/V ratio. Symbolically, Profit = [Margin of safety (amount)] × P/V ratio Or Profit = [Margin of safety (units) × CM per unit] In the vendor?s case, profit = Rs 2,400 × 0.3333 (33.33 per cent) = Rs 800 or 800 × Re 1 = Rs 800. The reason is that once the total amount of fixed costs has been recovered, profits will increase by the difference of sales revenue and variable costs.
16-7
1( b) Equation technique
The equation technique is particularly useful in situations where unit price and unit variable costs are not clearly defined. The excess of actual sales over the BE sales is the margin of safety. When margin of safety is divided by the actual sales, we get margin of safety ratio which indicates the percentage by which actual sales may decline without causing any loss to the firm
16-8
Sales revenue-Total costs = Net profit Breaking up total costs into fixed and variable, Sales revenue – Fixed costs – Variable costs= Net profit. Or Sales revenue = Fixed costs + Variable costs + Net profit. If S be the number of units required for break-even and sales revenue (SP) and variable costs (VC) are on per unit basis, the above equation can be written as follows: SP (S) = FC + VC (S) + NI Where SP = Selling price per unit S= Number of units required to be sold to break-even FC= Total fixed costs VC= Variable costs per unit NI= Net income (zero) SP (S)= FC + VC (S) + zero
SP (S) – VC (S)= FC
16-9
Example 2
SV Ltd, a multi-product company, furnishes you the following data relating to the current year:
Particulars Sales Total costs First half of the year Rs 45,000 40,000 Second half of the year Rs 50,000 43,000
Assuming that there is no change in prices and variable costs and that the fixed expenses are incurred equally in the two half-year periods, calculate for the year:
(i)The profit-volume ratio, (ii) Fixed expenses, (iii) Break-even sales, and (iv) Percentage margin of safety.
Solution Sales revenue – Total costs = Net profit Rs 45,000 – Rs 40,000 = Rs 5,000 (first half) Rs 50,000 – Rs 43,000 = Rs 7,000 (second half) On a differential basis: ? Sales revenue, Rs 5,000 – ? Total costs, Rs 3,000 = ? Total profit, Rs 2,000.
16-10
We know that only VC changes with a change in sales volume and, hence, change in total costs are equivalent to VC (Rs 3,000). Accordingly, the additional sales of Rs 5,000 has earned a contribution margin of Rs 2,000 [Rs 5,000 (S) – Rs 3,000 (VC)]. P/V ratio V/V ratio = Rs 2,000 ÷ Rs 5,000 = 40 per cent. = 100 per cent – 40 per cent = 60 per cent.
Accordingly, 60 per cent of the total costs are made up of variable costs and the balance represents the total fixed costs (FC). Sales revenue = Fixed costs + Variable costs + Net profit Rs 95,000 = FC + 0.60 × (Rs 95,000) + Rs 12,000 Rs 95,000 = FC + Rs 57,000 + Rs 12,000
Rs 95,000 – Rs 69,000 = FC or Rs 26,000 = FC
BEP (amount) = Rs 26,000 ÷ 0.40 = Rs 65,000
16-11
Verification Particulars Break-even sales Variable costs Contribution Fixed costs Net income Amount Rs 65,000 39,000 26,000 26,000 Nil Per cent 100 60 40 40 Nil
M/S ratio =
(Rs 95,000 – Rs 65,000
Rs 95,000
= 31.58%
16-12
Break-Even Application
Sales Volume Required to Produce Desired Operating Profit
(Fixed expenses + Desired operating profit) † P/V ratio
In Example 2, if the desired operating profit of SV Ltd is Rs 14,000, required sales volume = (Rs 26,000 + Rs 14,000)/0.40 = Rs 1,00,000 Operating Profit at a Given Level of Sales Volume
[Actual Sales Revenue (ASR) – Break-even Sales Revenue (BESR)] × P/V ratio
Effect on Operating Profit of a Given Increase in Sales Volume [Budgeted Sales Revenue (BSR) – BESR] × P/V ratio
Suppose that SV Ltd forecasts 10 per cent increase in sales next year, the projected profit will be: (Rs 1,04,500 – Rs 65,000) × 0.40 = Rs 15,800
16-13
Additional Sales Volume Required to Offset a Reduction in Selling Price Suppose that SV Ltd reduces its selling price from Rs 10 a unit to Rs 9. The sales volume needed to offset reduced selling price/maintain a present operating profit of Rs 12,000 would be:
Desired profit (P) + Fixed expenses (FC) = Rs (12,000 + Rs 26,000) † 0.3333 = Rs 1,14,000 Revised P/V ratio (Rs 3/Rs 9)
The required sales volume of Rs 1,14,000 represents an increase of about 20 per cent over the present level. The management should explore new avenues of sales potential to maintain the existing amount of profit
16-14
Effect of Changes in Fixed Costs A firm may be confronted with the situation of increasing fixed costs. An increase in the total budgeted fixed costs of a firm may be necessitated either by external factors, such as, an increase in property taxes, insurance rates, factory rent, and so on, or by a managerial decision of an increase in salaries of executives. More important than this in the latter category are expansion of the present plant capacity so as to cope with additional demand. The increase in the requirements of fixed costs would imply the computation of the following: (a) Relative break-even points. (b) Required sales volume to earn the present profits. (c) Required sales volume to earn the same rate of profit on the proposed expansion programme as on the existing ones. The effect of the increased FCs will be to raise the BEP of the firm. Assume the management of SV Ltd decides a major expansion programme of its existing production capacity. It is estimated that it will result in extra fixed costs of Rs 8,000 on advertisement to boost sales volume and another Rs 16,000 on account of new plant facility.
16-15
Multi-product Firms (Sales-mix) Example 3 The Garware Paints Ltd presents to you the following income statement in a condensed form for the first quarter ending March 31: Particulars Sales Variable costs Contribution Fixed costs Net income P/V ratio Break-even sales Sales-mix (per cent) Product X Rs 1,00,000 80,000 20,000 Y Rs 60,000 42,000 18,000 Z Rs 40,000 Rs 2,00,000 24,000 1,46,000 16,000 54,000 27,000 27,000 0.40 0.27 1,00,000 0.20 100 Total
0.20 0.50
0.30 0.30
If Rs 40,000 of the sales shown for Product X could be shifted equally to products Y and Z, the profit and the BEP would change as shown in Table 2.
16-16
Table 2 Break-even Point Particulars Sales Less: Variable costs Contribution Less: Fixed costs Net income P/V ratio BE sales Sales-mix (per cent) Product X Y Z Rs 60,000 Rs 2,00,000 36,000 1,40,000 24,000 60,000 27,000 33,000 0.40 0.30 90,000 0.30 100 Rs 60,000 Rs 80,000 48,000 56,000 12,000 24,000 Total
0.20 0.30
0.30 0.40
Example 3 shows that by increasing the mix of high P/V products (Y from 30 to 40 per cent, Z from 20 to 30 per cent) and decreasing the mix of a low P/V product (X from 50 to 30 per cent), the company can increase its overall profitability. In fact, it can further augment its total profits, if it can make, and the market can absorb, more quantities of Y and Z, say Rs 1 lakh each (Table 3).
16-17
Table 3 Particulars Sales Less: Variable costs Contribution Less: Fixed costs Net income P/V ratio BE sales Sales-mix (per cent) Product Y Rs 1,00,000 70,000 30,000 Z Rs 1,00,000 60,000 40,000 Rs 2,00,000 1,30,000 70,000 27,000 43,000 0.35 77,143 100 Total
0.30 0.50
0.40 0.50
From the above, it can be generalised that, other things being equal, management should stress products with higher contribution margins. For individual product line income statements, fixed costs should not be allocated or apportioned.
16-18
2(a) Break-Even Chart
The break-even chart is a graphic presentation of the relationship between costs, profits, and sales. It shows not only the break-even sales but also the estimated costs and profit at various levels of the sales revenue. It is, therefore, also referred to as volume-cost-profit (VCP) graph/chart
Assumptions Regarding the VCP Graph are
1. Costs can be bifurcated into variable and fixed components. 2. Fixed costs will remain constant during the relevant volume range of graph. 3. Variable cost per unit will remain constant during the relevant volume range of graph. 4. Selling price per unit will remain constant irrespective of the quantity sold within the relevant range of the graph. 5. In the case of multi-product companies, in addition to the above four assumptions, it is assumed that the sales-mix remains constant. 6. Finally, production and sales volumes are equal.
16-19
Example 4
Selling price per unit Fixed costs Variable costs per unit Relevant range (units) : Lower limit : Upper limit Break-up of variable costs per unit: Direct material Direct labour Direct expenses Selling expenses Actual sales, 18,000 units (Rs 1,80,000) Plant capacity, 20,000 units (Rs 2,00,000) Tax rate, 50 per cent Rs 10 60,000 5 6,000 20,000 Rs 2 1.50 1 0.50
16-20
Y 200 Revenue and costs (in „000 rupees) 180 160
Relevant range
Variable cost area 140 120 100 80 60 40 20 0
0 4 6 8 12 16 18 20 24 Sales volume (in thousand units) Rs 120 Rs 180 Rs 240 Sales revenue (in thousand units) 40% 60% 80% Per cent of plant capacity 28 30 Rs 300 100%
BEP Margin of safety (units) Fixed cost line
Fixed cost line X
Or Rs 60 20%
Figure 1: Volume-Cost-Profit Graph (Traditional)
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Figure 1 has been drawn by using a sales line and a total cost line (including both fixed and variable costs). The steps involved in drawing the VCP graph are enumerated as follows: 1. Select an appropriate scale for sales volume on the horizontal axis, say, 2,000 units (Rs 20,000) per square, and plot the point for total sales revenues at relevant volume: 6,000 units × Rs 10 = Rs 60,000. Draw the sales line from the origin to Rs 2,00,000 (the upper limit of the relevant range). Ensure that all the points, 0, Rs 60,000 and Rs 2,00,000 fall in the same line. This should be ensured for the total cost line also. 2. Select an appropriate scale for costs and sales revenues on the vertical axis, say, Rs 10,000 per square. Draw the line showing Rs 60,000 fixed cost parallel to the horizontal axis.
3. Determine the variable portion of costs at two volumes of scales (beginning and ending): 6,000 units × Rs 5 = Rs 30,000; 20,000 units × Rs 5 = Rs 1,00,000.
4. Variable costs are to be added to fixed costs (Rs 30,000 + Rs 60,000 = Rs 90,000). Plot the point at 6,000 units sales volume and Rs 1,00,000 + Rs 60,000 = Rs 1,60,000. Point is to be plotted at 20,000 units sales volume. This obviously is the total cost line. 5. The point of intersection of the total cost line and sales line is the BEP. To the right of BEP, there is a profit area and to the left of it, there is a loss area. 6. Verification: FC ÷ CM per unit = Rs 60,000 ÷ Rs 5 per unit = 12,000 units or Rs 1,20,000
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Figure 1 has been drawn using different scales for the horizontal and vertical axis. Figure 2 has been drawn on a uniform scale for both axes. Since the scales are the same, the 45° line will always be the proxy of the sales line. Any amount of sales revenue on the horizontal axis will correspond to costs and revenue on the vertical axis. Let us illustrate taking two sales levels.
1. Rs 60,000: FC = Rs 60,000 VC = 30,000 (50 per cent variable cost to volume ratio) TC = 90,000 Loss = 30,000 (TC, Rs 90,000 – Rs 30,000, sales revenue) Thus, Rs 60,000 = Rs 60,000 + Rs 30,000 – Rs 30,000. Point A in Figure 2 clearly shows these three relevant figures at the sales volume of Rs 60,000.
2. Rs 1,80,000: FC = Rs 60,000 VC = 90,000 TC = 1,50,000 Profit = 30,000 Thus, Rs 1,80,000 = Rs 60,000 (FC) + Rs 90,000 (VC) + Rs 30,000 (Profit). Point B in Figure 2 portrays these three relevant figures at the sales volume of Rs 1,80,000.
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Y 240
Revenue and costs (in „000 rupees)
200
160 120 BEP
80
Fixed cost line
40
0 40 0 60 80 120 140 160 180 200 240
X
Sales revenue (in „000 rupees)
Figure 2: Volume-Cost-Profit Graph, Same Scale
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The VCP graph in Figure 3 is drawn with the details of the individual segment of variable cost and is more informative. The steps involved in drawing the graph include an additional step of adding variable costs to the fixed cost. This is to be repeated four times for four different components: material, labour, direct expenses and selling expenses. In fact, fixed costs can also be further split-up into parts. Such a graph provides a bird?s-eye view of the entire cost structure to the management. By drawing a line perpendicular from any volume (horizontal axis), the corresponding cost and profit variables can be ascertained on the vertical axis. For instance, at 20,000 unit level, following are the various cost figures, as shown by the VCP graph (line A). Fixed costs Variable costs: Material Labour Direct expenses Selling expenses Profit before taxes Rs 60,000 40,000 30,000 20,000 10,000 40,000
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Y 200
Rs 20,000 Net income Income tax
Selling expenses
Revenue and costs (in „000 rupees)
160 BEP 120
Rs 20,000
Rs 10,000
Variable costs & expenses
Rs 20,000
Direct expenses Direct labour cost
Total costs and expenses
Rs 30,000
80
Rs 40,000
Direct material cost
40
Rs 60,000
Fixed expenses (Factory, administration, selling)
X
4
8
12
16
20
Sales Volume (in thousand units)
Figure 3: Volume-Cost-Profit Graph, Cost-Wise
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The VCP graph can be modified to show the changes in the profitability factors of Example 4, such as, 1.Change in fixed costs (Rs 10,000 both ways) 2.Change in variable costs (20 per cent both ways) 3.Change in selling price (25 per cent both ways). Table 4 provides a summary of the results due to the above changes. Only one change is taken at a point of time.
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Table 4 Variable Fixed costs (Rs 10,000): Increase Decrease (Figure 4) Variable costs: Increase (to 60 per cent) Decrease (to 40 per cent) (Figure 5) Selling price (25 per cent): Increase Decrease (Figure 6) Effect on BEP Increase (Rs 20,000) Decrease (Rs 20,000) Margin of safety Decrease (Rs 20,000) Increase (Rs 20,000) Operating profit Decrease (Rs 10,000) Increase (Rs 10,000)
Increase (Rs 30,000) Decrease (Rs 20,000)
Decrease (Rs 30,000) Increase (Rs 20,000)
Decrease (Rs 18,000) Increase (Rs 18,000)
Decrease (Rs 20,000) Increase (Rs 60,000)
Increase (Rs 20,000) Increase (Rs 60,000)
Increase (Rs 18,000) Decrease (Rs 30,000)
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doc_580641624.pptx