Introduction: CVP Analysis:
Cost-volume-profit (CVP) analysis is used to determine d etermine how changes in costs and volume affect a company's operating income and net income. In performing this analysis, there are several assumptions made, including:
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Sales price per unit is constant.
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Variable costs per unit are constant.
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Total fixed costs are constant.
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Everything produced is sold.
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Costs are only affected because activity changes.
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If a company sells more than one product, they are sold in the same mix.
Managers need to estimate future revenues, costs, and profits to help them plan and monitor operations. They use cost-volume-profit (CVP) analysis to identify the levels of operating activity needed to avoid losses, achieve targeted profits, plan future operations, and monitor organizational performance. Managers also analyze operational risk as they choose an appropriate cost structure.
CVP analysis requires that all the company's costs, including manufacturing, selling, and administrative costs, be identified as variable or fixed.
Contribution margin and contribution margin ratio
The contribution margin represents the amount of income or profit the company made before deducting its fixed costs. Said another way, it is the amount of sales dollars available to cover (or contribute to) fixed costs. When calculated as a rat io, it is the percent of sales dollars available to cover fixed costs. Once fixed costs are covered, the next dollar of sales results in the company having income.
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The contribution margin is sales revenue minus all variable costs. It may be calculated using dollars or on a per unit basis.
Break-even point
The break-even point represents the level of sales where net income equals zero. In other words, the point where sales revenue equals total variable costs plus total fixed costs, and contribution margin equals fixed costs.
Targeted income
CVP analysis is also used when a company is trying to determine what level of sales is necessary to reach a specific level of income, also called targeted income. To calculate the required sales level, the targeted income is added to fixed costs, and the total is divided by the contribution margin ratio to determine required sales dollars, or the total is divided by contribution mar gin per unit to determine the required sales level in units.
CVP-Graph:
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Objective of Study: Primary objective: •
To fulfill the course requirement.
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To acquire knowledge.
Secondary Objective: •
To get an idea about the road side business.
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To get an idea about the financial performance of the business.
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Analysis and evaluate the cost volume profit analysis of that business.
Methodology: To prepare this report, we used primary data. We have collected all those data from the proprietor of the business
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Limitation: Limitation is a usual part of report analysis. Whenever any report is going on to analyze, there are several lacking to find out the result of the particular topic. To make this report, we also faced some problems. Time constrains was another problem. But while preparing the report we came to learn lots of practical things and have gathered practical knowledge and finally we have enjoyed a lot to prepare the whole paper work.
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Company Profile: Karnataka Tea Stall is a renowned tea stall located in Banshankri 3 rd stage , Banglore. Its owner name is Shahbuddin. He is only man who makes tea & served another thing. It has two benches & one chair. There is one big box for protect the fire of stove from the air. His stall is decorated with one stove, Two Aluminum tea pot, 12 cups, two or three spoon & a pot for making tea. Some sweet, cake, bread are displayed by hanging them in packet on his stall. The stall has one water purifying machine for serving pure water. He everyday sell about 250 cup tea, 50 sweet, 60 paces of cake.
List of product: Tea dust Sugar Milk Oil Water bottle Cake Banana Sweet Biscuit
Per day 0.4kg 1.5kg 5 Tin 1.5 liter 2 bottle 52 pieces 100 pieces 35 pieces 50 pieces
Other Cost Glass Stove and etc Box Chair & Bench Water purifying machine Tea pot Electricity Light Rent
Price 114/90/240/100/80/200/300/80/70/-
180/1,800/600/1,150/7,400/600/200/200/1,500/-
Variable cost (For one month):
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Product:
Purchasing cost
Tea dust Sugar Milk Oil Water bottle Cake Banana Sweets Biscuit Total
3,400/2,700/7,200/3,000/2,400/6,000/9,000/1,650/2,100/37,450/-
Fixed cost:
Product: Glass Stove Burner Box Chair & Bench
Cost 180/1,800/600/1,150/-
Water Purifier Machine Electricity Bill Expense Tea Pot Electric Bulb Rent Expense Total
7,400/200/600/200/2,000/14,130/-
Unit of Production: Item
Per day
Month
Unit Price
Selling Price
Tea Cake
200cup 52 pieces
6,000 cups 1,560 pieces
5.0/cup 5.00/piece
30,000 7,800
Banana
100 pieces
3,000 pieces
5.00/piece
15,000
Sweets
35 pieces
1,050 pieces
3.00/sweet
3,150
Water bottle
2 bottle
60 bottle
55.00/jar
3,300
5
Biscuit
Total
50 pieces
1500 pieces
3.00/unit
4,500
63,750
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Analysis: Helal Tea stall produced has a single product & sell 5 product. This information are taken from the original data those are flowing:
Sell: 6,000 cup tea, 1,560 pieces cake, 3000 pieces banana, 1,050 pieces sweets, 60 water bottle & 1500 pieces Biscuit =13,170 units
Selling price per unit (63,750/13,170) = 4.8405/- per unit Variable cost per unit (37450/13170) = 2.8435/- per unit Fixed Cost 14130 Taka Contribution Margin (4.8405-2.8435) = 1.9969/- per unit
We separated the variable and fixed expenses from original data: Sales (13,170*4.8405)
Tk.63,750
Less: Variable cost (13,170*2.8435)
Tk.37,450
Contribution (13,170*1.9969)
Tk.26,300
Less: Fixed cost
Tk.14,130
Net operating income
Tk.12,170
Contribution margin ratio(C/M ratio): To compute change in contribution margin and net operating income resulting from change in sales volume: C/M ratio
= Contribution per unit /Sales per unit =1.9969/5 =39.9938%
Here c/m ratio 39.9938% means that for each volume increase in sales.
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BEP sales in units: Break even sales as the level of sales at which the company’s profit is zero. BEP sales in units = Fixed cost/Contribution per unit =14,130 / 1.9969 = 7,076 units
BEP sales in volume = 7,076 units*4.8404 = Tk. 32,250.6704
Degree of operating leverage: The degree of operating leverage is a measure at a given level of sales of how a percentage change in sales volume will be affect profits.
Degree of operating leverage = Contribution Margin / Net operating Income =26,300 / 12,170 =2.16105 times Here, degree of operating leverage is 2.16105 the tea Stall net operating Income grows 2.5386 times as fast its sales.
Assume set the farm target profit is Tk.20, 000.How many units would have to be sold?
Target sales in units: (Fixed cost + Target profit)/ Contribution per unit = (14,130 + 15,000) / 1.9969 =14,588 units
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Conclusion: Cost volume profit (CVP) measure how volume is the company product volume unit. If the company produces less than BEP the company must be loss and the company produce more than the company must be earn profit. As because CVP analysis helps managers understand the interrelationships among cost, volume, and profit it is a vital tool for taking business decisions. In this report analysis we have found that Mr. Shahbuddin take the decision about the profitably condition of his business, that if he wants to make a profit of Tk. 20000.00, he have to sell a amount of 14588 unit of product which is larger than his existing sells unit that is 13170 units. In this report we tried to find out the cost and profit In conclusion, we would like to say that, it was a great experience to do this report. We actually got to know a lot of things. The things we study at classroom are not only bookish things rather they are being implemented in real world. We tried to cover all ratio of analysis the financial statement. But let that not be any excuse rather we take all the blame on my shoulder regarding any flaw of this report.
Break even analysis — Document Transcript
1. Break Even AnalysisIt is a widely used technique to study the cost -volume –profit relationship. Thenarrower interpretation of term break –even analysis refers to system ofdetermination of that level of activity where total cost equals total selling price. Thebroader interpretation refers to that system of analysis which determines probableprofit at any level of activity. It portrays the relationship between the cost ofproduction, volume of production and sales value.Break –even analysis
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indicates the level of sales at which cost and revenue are inequilibrium .The equilibrium point is commonly known as break even point, Thebreak even point is that point of sales volume at which total revenue is equal to totalcost.Utility of Break Even Analysis:It is the most useful technique of profit planning and control. It is a device to explainthe relationship between the cost volume profit .The utility of break even analysislies in the following advantages:1) Provided detailed and understandable information:Break even analysis is a simple concept to present and interpret accounting data.Many business executives and other are unable to understand accounting datacontained in the financial statements and reports but break even charts visualizesinformation very clearly and a look at a glance shall give a vivid picture of wholeaffairs. The different elements of cost direct material, direct labour, overheads(factory, office and selling etc) can be presented through an analytical break evenchart. Further the information is in a simple format therefore it is clearlyunderstandable even to layman.2) Profitability of product and business can be known:The profitability of different can be known with the help of break even chart,besides the level no profit no loss .The problem of managerial decision regardingtemporary or permanent shutdown of business or continuation at a loss can besolved by break even analysis .It is thus provides the 10
basis information for profitimprovement studies and it is useful starting point for the detailed investigation.3) Effects of changing of cost and sales price can be demonstrated:The effect of changes of fixed and variable cost at different level of production onprofits can be demonstrated by graph legibly. In other words relationship of cost,volume, profit at different level of activity and varying selling prices is shownthrough chart. Thus it studied requisites for survival of the company.4) Cost control can be analyzed: The relative importance of fixed in the total cost of product can be analyzed and ifthe total cost are high, they can be controlled by the management. Thus it is a 2. managerial tool for control and reduction of cost, elimination of wastages andachieving better efficiency.5) Economy and efficiency can be affected:The capacity can be utilized to fullest possible extent and economies of scale andcapacity utilization can be affected. Comparative plant efficiency can be studied onbreak even chart. The efficiency of output is indicated by the angle of incidenceformed at intersection of sales line and the variable cost.6) Diagnostic tool:It is useful diagnostic tool. It indicates to management the cause of increasing breakeven point and falling profit the analysis of these causes will reveal that what actionshould be taken. If break even point as a percentage of capacity is increasing, itindicates the unfavorable condition and need immediate 11
action .It is possible thatdue to plant expansion absolute break even point may increase. This situation wherebreak even point as a percentage of capacity may does not increase, is notunfavorable.Limitation of break even analysisThough break even analysis is a simple and useful concept but it is based on thecertain assumption which limits its utility and general applicability. However itsuffers from the following limitations:1) Based on the false assumptions:A) Cost segregation: It is difficult to classified fixed and variable cost. However some of the can be easilyidentified as fixed such as rent of building, or variable such as direct material costbut a large number of cost belong to mixed category .such cost known as semivariable cost consists of fixed as well as variable cost and are difficult to separate. B) Fixed cost remains constant:The assumption that fixed costs remain constant does not hold good. If a firm haszero output some of fixed cost can certainly be reduced or eliminated. For examplesome of the supervisors can be dismissed and the salaries can be reduced. On theother hand if the company uses its ideal capacity additional fixed cost may beincurred. Thus fixed costs are not constant and can change in the stepwise fashion.C) Variable cost very proportionately:The variable cost does not change in the same proportion as volume of productionor sales changes. for example if the company increases its production or sales it needmore workers who may be less efficient and 12
less experienced or existing workersneed overtime and company have to pay for it. Similarly material cost will be lessdue to purchase, discounts, if purchases in bulk. So lines drawn are not straight andsometimes a curved line is obtained in respect of total cost. 3. d) Change in selling price:Similarly selling price may remain the constant under the perfect competition. Butin the real market situation of monopolistic completion or oligopoly selling pricehave to be reduced to increase the sales volume. Thus sales revenue will not changein the direct proportion with output.e) Stock changes do not affect incomes:The break even chart depicts volume of production or sales along x axis and thusignores the effect of changes in stock volume. As a matter of fact it is assumed thatstock changes will not affect income, but it is not true since the absorption of fixedcost depends on the production and not on sales.2) Limited information: can be presented in a single break even chart. If we have tostudy changes of fixed cost, variable cost and selling prices, a number of charts willhave to be drawn up Similarly when a number of products are manufactured it would a difficulttask to present information through single break even chart.3)Short term focus: It is a short term technique of profit planning and can not beused for the long term planning because it lead to long term decision. For example acompany wishes to increase his productive capacity and it may not yield enoughrevenue in the first 13
year. Thus in the term of break even analysis company maydrop idea of adding to productive capacity, but it may be beneficial over a longperiod of time.4) NO necessity: There is no necessity; of preparing the break even charts onaccount of the following reasons:A) Simple tabulation sufficient: because result of cost and sales can serve thepurpose which is served by break even chart. Hence the need of presentationthrough chart and using mathematical tool of break even analysis does not arise.b) Conclusive guidance not provided: No conclusive basis for action is provided tomanagement by technique of breakeven analysis,c) Difficult to understand: The chart becomes very complicated and difficult tounderstand particularly for the non technical man, if number of lines or curvesdepicted on graph is larged) No basis for comparative efficiency:Charts do not provide any basis for the comparative efficiency between the differentunits. In spite of all above limitation it remain an important tool for the profitplanning what is needed is that financial analyst should understand underlyingassumption and their corresponding limitation and adjust his data appropriately tosuits his needs.
Assumptions underlying break-even analysis: 1.
Total Costs can be easily classified into Fixed and
Variable categories.
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2.
Selling Price per unit remains constant,
irrespective of quantity sold. 3.
Variable Costs per unit remain constant. However
total variable costs increase as output increases. 4.
Fixed Costs remain the same irrespective of
output. 5.
Productivity of the factors of production will
remain the same. 6.
The state of technology, process of production
and quality of output will remain unchanged. 7.
There will be no significant change in the level of
opening and closing inventory. 8.
The company manufactures a single product. In
the case of a multi-product company, the sales Unchanged. 9.
Both revenue and cost functions are linear over
the range of activity under consideration,
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