Cost Volume Profit (C. V. P.).
Profit depends upon many factors, but most important is the cost of Manufacturer, volume of sales and selling price of the product. The three factors of cost, volume and profit are inter-connected and dependent on each other. Profit depends upon sales, slaes price depends upon cost, volume of sales depends upon Volume of production which in turn depends upon volume of production, which in turn, is related to cost.
Thus C.V.P. analysis is an attempt to measure variations in cost with variations in volume. Volume is the most important factor which effects cost.
Importance of C.V.P.
Main advantages are as:
(i) Helpful in determining volume of output. It is useful in knowing the most profitable level of output. Thus, production capacity can be utilized to the maximum limit.
(ii) Selection of best alternative. The Cost Volume Profit (C.V.P.) analysis is useful in knowing the best course of action.
(iii) Make buy decision. C.V.P. is very useful in decision making whether a product should be produced or be bought from the market. This is done by matching the purchase price to the cost of output.
(iv) Decision regarding the use of machine or man. C.V.P. is useful in determining which method should be adopted for manufacturing a particular product. The use of machine or man of the two which one is most suitable can be suggested easily with the application of C.V.P. analysis.
Profit Volume Ratio (PVR)
The Profit Volume Ratio (PVR) is useful in determining the profitability of business. This ratio is associated with contribution and sales and is always expressed in percentage.
Formula to calculate Profit Volume Ratio
PVR = (C x 100) / S
C = Sales – Variable Cost
Fixed expenses $80,000, Sale per unit $20 Variable cost per unit $15.
C = 20 – 15 = 5
PVR = (5 / 20) x 100 = 25%
A high PVR is the indication of high profitability. It is also useful in determining the BEP, Profit at any volume of sales.
Margin of Safety (MOS)
Margin of Safety is the excess output in units or sales over BEP output (units) and sales. It is an indicator of Profitability, in such situation no danger of loss.
Formula to Calculate Margin of Safety
MOS = Present sales – BEP (Sales)
= (Excess sales x 100) / Total present sales
MOS = Net Profit / PVR
PVR = (C / 5) x 100
Present Sales = $1,00,000
Variable Cost = $50,000
Fixed Cost = $30,000
The MOS can be calculated as:
PVR = (C / 5) x 100 = (50,000 / 1,00,000) x 100 = 50%
BEP (Sales) = Fixed Exp. / PVR
BEP (Sales) = 30,000 / 50% = (30,000 x 100) / 50 = $60,000
Net Profit (NP) = Contribution – Fixed Cost
= 50,000 – 30,000 = $20,000
Margin of Safety (MOS) = Actual Sales – BEP Sales
= 1,00,000 – 60,000
MOS = 40,000
MOS = NP / PVR
= 20,000 / 50% = (20,000 x 100) / 50 = 40,000
Margin of safety in Percentage = (40,000 / 1,00,000) x 100 = 40%
The high MOS indicates financial soundness of business. When MOS is not good, then the following actions are recommended.
(i) Try to reduce fixed cost
(ii) Try to reduce variable cost
(iii) Try to increase sales price
(iv) Try to improve contribution by changing sales mix.
Angle of incidence
This is reverse of MOS., here present output and sales will be lesser than BEP output (Units) and sales. It is an indicator of loss. This is an angle formed with the sales line and total cost line at the BEP point. Thus,
BEP Unit = 16000, Present output is 15000 Units. Calculate loss when sale per unit is $20, variable cost is $15.
Angle of incidence = Present output – BE Product (15,000 – 16,000 units)
= 1,000 units.
Loss = 1000 x C (5) = $5,000