Chapter one

Cost-Volume-Profit (CVP) Analysis

Unit Outline
 Unit Objectives
1.1 Introduction
1.2 Meaning, underlying Assumptions and importance of CVP analysis
1.2.1 Meaning of CVP analysis
1.2.2 The Basic Assumptions of CVP Analysis
1.3 Applications of CVP Analysis
1.3.1 Break Even Analysis
1.3.2 Target operating Income Analysis
1.3.3 The impact of Income Tax on CVP Analysis
1.3.4 Sensitivity Analysis
1.3.5 Margin of Safety
1.4 Multiple Product Company and Cost-Profit-Volume Analysis
1.4.1 Contribution Margin Technique and Breakeven Point for a Multi Product
Company
1.4.2 Contribution margin technique and sales required for desired income for a
multi-product company
1.5 Not for Profit Organizations and Cost-Profit-Volume (CVP) Analysis
 Unit Summary
 Model Examination Questions
Unit Objectives:
After completing this unit you are expected to:
 What are the objectives of cost volume profit analysis (CVP Analysis)?
 Understand the assumptions underlying cost-volume-profit (CVP) analysis.
 Explain the features of CVP analysis.
 Determine the breakeven point and output level needed to achieve a target operating
income
 Understand how income taxes affect CVP analysis
 Explain CVP analysis in decision making and how sensitivity analysis helps managers
cope with uncertainty
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 Apply CVP analysis to a company producing Multiple products

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 Apply CVP analysis to service rendering Not for Profit organizations

1.1 Introduction
In this unit you will be introduced with one of the most powerful management accounting tool
that helps managers in quick decision about the income generated at different activity level. The
tool is termed as Cost-Volume-Profit (CVP) Analysis, as the relationship among cost, profit and
the volume of output or the level of activity is considered in the model.
Understanding the relationship between a firm’s costs, profits and its volume levels is very
important for strategic planning. When you are undertaking a new project, you will probably ask
yourself, “How many units do I have to produce and sell in order to breakeven?” The feasibility
of obtaining the level of production and sales indicated by that answer is very important in
deciding whether or not to move forward on the project in question. Similarly, before
undertaking a new project, you have to assure yourself that, you can generate sufficient profits in
order to meet the profit targets set by your firm. Thus, you might ask yourself, “How many units
do I have to sell in order to produce a target income?” Breaking Even? You could also ask, “If I
increase my sales volume by certain percent, what will be the impact on my profits?” The topics
in this unit are, therefore designed to acquaint you with the ability of applying Cost-Volume-
Profit (CVP) Analysis in answering different questions while you are taking part in planning
decision in different types of organizations.
Although the term “profit” is attached in the CVP model; it does not mean that, the application of
CVP analysis is limited to business organizations only. It can be used by government and
nongovernmental organizations (NGOs) as well in planning their activity levels in light of the
recourse availability and constraints.
1.2 Meaning, Underlying Assumptions and Importance of CVP Analysis
1.2.1 Meaning
Examining shifts in costs and volume and their resulting effects on profit is called cost-volume-
profit (CVP) analysis. This analysis is applicable in all economic sectors, including
manufacturing, wholesaling, retailing, and service industries and not-for- profit (NFP)
organizations. CVP can be used by managers to plan and control more effectively because it
allows them to concentrate on the relationships among revenues, costs, volume changes, taxes,
and profits.
CVP analysis can be used to determine a company’s break-even point (BEP), which is that
level of activity, in units or Birr value, at which total revenues equal total costs. At breakeven,
the company’s revenues simply cover its costs; thus, the company incurs neither a profit nor a
loss on operating activities. Companies, however, do not wish merely to “break even” on
operations.
The break-even point is calculated to establish a point of reference. Knowing BEP, managers are
better able to set sales goals that should generate income from operations rather than produce
losses. CVP analysis can also be used to calculate the sales volume necessary to achieve a
desired target profit. Target profit objectives can be stated as either a fixed or variable amount
on a before- or after-tax basis. Because profit cannot be achieved until the break-even point is
reached, the starting point of CVP analysis is BEP. It also helps in conducting a sensitivity
analysis to understand how the change in variables in the CVP model affects the profitability.
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After going through the major assumptions upon which the CVP model is developed, you will be
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exposed through the application of CVP in determining the BEP, target profit; in a single and
multiple product companies. You will also come across on how CVP is used to conduct a
sensitivity analysis as well as its application in NFPs.
Notice that on advanced managerial accounting courses you will come across with diverse and
advanced applications of CVP analysis in various financial and strategic decisions.
 Cost-volume-profit analysis determines how costs and profit react to a change in
the volume or level of activity, so that management can decide the 'best' activity
level.
 1.2.2 Underlying Assumptions of CVP Analysis
CVP analysis is a short-run model that focuses on relationships among several items: selling
price, variable costs, fixed costs, volume, and profits. This model is a useful planning tool that
can provide information on the impact on profits when changes are made in the cost structure or
in sales levels. However, the CVP model, like other human-made models, is an abstraction of
reality and, as such, does not reveal all the forces at work. It reflects reality but does not
duplicate it. Although limiting the accuracy of the results, several important but necessary
assumptions are made in the CVP model. These assumptions follow:
1. All revenue and variable cost behavior patterns are constant per unit and linear within the
relevant range.
2. Total contribution margin (total revenue - total variable costs) is linear within the relevant
range and increases proportionally with output. This assumption follows directly from
assumption 1.
3. Total fixed cost is a constant amount within the relevant range.
4. Mixed costs can be accurately separated into their fixed and variable elements. Although
accuracy of separation may be questioned, reliable estimates can be developed from the
use of regression analysis or the high-low method.
5. Sales and production are equal; thus, there is no material fluctuation in inventory levels.
This assumption is necessary because of the allocation of fixed costs to inventory at
potentially different rates each year. This assumption requires that variable costing
information be available. Because both CVP and variable costing focus on cost behavior,
they are distinctly compatible with one another.
6. There will be no capacity additions during the period under consideration. If such
additions were made, fixed (and, possibly, variable) costs would change. Any changes in
fixed or variable costs would violate assumptions 1 through 3.
7. In a multiproduct firm, the sales mix will remain constant. If this assumption were not
made, no weighted average contribution margin could be computed for the company.
8. There is either no inflation or, if it can be forecasted, it is incorporated into the CVP
model. This eliminates the possibility of cost changes.
9. Labor productivity, production technology, and market conditions will not change. If any
of these changes occur, costs would change correspondingly and selling prices might
change. Such changes would invalidate assumptions 1 through 3.
These assumptions limit not only the volume of activity for which the calculations can be made,
but also the time frame for the usefulness of the calculations to that period for which the
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specified revenue and cost amounts remain constant. Changes in either selling prices or costs
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will require that new computations be made for break-even and product opportunity analyses.
The nine assumptions listed above are the traditional ones associated with CVP analysis. An
additional assumption must be noted with regard to the distinction of variable and fixed costs.
Accountants have generally assumed that cost behavior, once classified, remained constant over
periods of time as long as operations remained within the relevant range. Thus, for example,
once a cost was determined to be “fixed,” it would be fixed next year, the year after, and 10 years
from now.
The above assumptions thus, imply that cost-volume-profit analysis is always based on
contribution per unit (assumed to be constant unless a question clearly says otherwise) and never
on profit per unit because profit per unit changes every time a few more or less units are made.
Activity 4.1:
a) Explain how CVP helps for management decision making process
b) List and explain the underline assumptions in a CVP analysis
1.3 Applications of CVP Analysis
 Dear learners in the previous parts of this unit you have gone through the meaning
and underlying assumptions of CVP. As you have learnt CVP can be used by
managers in a variety of sectors as management decision tool.
On the subsequent part of the module you will find an explanation and illustrations on the
applications of CVP in different scenarios.
1.3.1 Break Even Analysis
CVP analysis has wide-range applicability. It can be used to determine a company’s break-even
point (BEP), which is that level of activity, in units or dollars/Birr, at which total revenues equal
total costs. At breakeven, the company’s revenues simply cover its costs; thus, the company
incurs neither a profit nor a loss on operating activities.
 At the breakeven point total revenue is equal to total cost (both variable and fixed)
For instance Sebastopol Cinema sold 4,800 tickets during a show one month run. The following
contribution margined approach income statement show that the operating income for the month
will be zero:
Sales Revenue (4800 X Br25) --------------------------- Br 120, 000
Less Variable Cost (4800 X Br 15) -------------------------- 72,000
Total Contribution Margin----------------------------------Br 48,000
Less Fixed Costs-------------------------------------------------- 48,000
Operating Income---------------------------------------------------Br 0
The income statement above highlights (1) the distinction between variable and fixed cost and
(2) the total contribution margin, which is the amount that contributes towards covering
Sebastopol Cinema’s fixed cost and income generation. To state it differently, each ticket sold
add Birr 10 to the firm’s bottom line profit. The Birr 10 unit contribution margin is derived by
deducting the unit variable cost Birr 15 from Birr 25 the unit selling price of a ticket.
How could you compute Sebastopol Cinema’s breakeven point if you didn’t already know it is
Birr 4,800 tickets per month? Well on the following discussion you will get the basics of CVP
analysis to determine BEP and other application. CVP analysis can be done using three
alternative approaches, namely: contribution margin approach, equation approach and graphical
approach.
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In discussing CVP application we will assume that the following variables have the meanings
given below:
 SP = Selling Price Per Unit
 Q = Units Produced and Sold
 VCU = Variable Cost Per Unit
 CMU=contribution margin per Unit
 CM%= contribution margin percentage (CMU÷SP)
 FC = Total Fixed Costs
 TOI =Target operating Income
 TNI=Target Net Income
  t = Tax rate
1.3.1.1 Equation Method
In using equation approach to CVP analysis, you need to convert your income statement in the
following equation form.
Revenue –Variable Costs- Fixed Costs = Operating Income
Your Sales Revenue is equal to the number of units sold times the price you get for each unit
sold:
Sales Revenue = SPQ
Assume that you have a linear cost function, and your total costs equal the sum of your Variable
Costs and Fixed Costs:
Total Costs = Variable costs + Fixed costs
The profit equation can, therefore rewritten as:
(SPXQ) - (VCUXQ) + FC = OI
This equation provides the most general and easiest approach to remember approach to any CVP
situation. The determination of breakeven level using this method can easily performed by
making the operating income on the right hand side of the equation zero. Here the basic
assumption is that, when you are at breakeven, your Sales Revenue minus your Total Costs is
zero.
 At breakeven point,
(SPXQ) - (VCUXQ) + FC = 0
From the information given above for the Sebastopol Cinema, you can determine the breakeven
point (BEP) using the equation approach as follows:
(Br25 X Q) – (Br15 X Q) + Br48, 000 = 0
Br10Q = Br 48,000
Q= 4,800
If Sebastopol sells fewer than 4800 tickets, it will have a loss, if it sells 4800 tickets, it will
breakeven; and if the sales are more than 4800 units, it will make a profit.
The breakeven point stated in units can be stated in terms of Birr by multiplying the breakeven
quantity and unit selling price. The breakeven point in Birr= BEQ x SP
= 4,800 x Br25
= Br120, 000
1.3.1.2 Contribution Margin Approach
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The contribution margin technique is merely a short version of the equation technique. The
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formulas used in the determination of the breakeven point in unit as well as in value are derived
by the rearrangement of the terms in the equation method above, which is
(SP x Q) – (VCU x Q) – FC = OI
Re-written equation takes the following format:
(SP-VCU) x Q = FC + OI
That is, Q= FC + OI/ (SP-VCU)
The difference between unit selling price and unit variable cost is termed as unit contribution
margin. You can replace the (P-V) by the term "Contribution Margin per Unit (CMU),
Q = FC + OI/CMU
As you know from the discussion above at breakeven point the target operating income is Birr 0,
so replacing OI by 0, you will get,
Q = FC/ (SP-VCU)
A. Breakeven point in units using contribution Margin Approach
Breakeven point in units using this formula is determined by dividing the total fixed cost by the
contribution margin per unit due to the fact that this approach centers on the idea that each unit
sold provides a certain amount of fixed costs. When enough units have been sold to generate a
total contribution margin equals to the total expense and only after that point the units sold
contributes for profit of the organization.
The breakeven number of tickets that Sebastopol Cinema must sold to reach at breakeven using
this method can be determined as:
Q = FC/CMU
Q = Br 48, 000/Br10
Q = 4,800 units
B. Determining breakeven point in terms of sales value (Dollar/Birr)
To find the breakeven sales value, you can use contribution margin percentage in place of
contribution margin per unit in the formula you used in the determination of breakeven units.
Contribution margin percentage is simply the ratio of contribution margin to selling price.
CM% = CMU/USP
It can also determined by dividing the total contribution margin to total sales when the unit
selling price and variable cost is not known. We will see how this formula is used in such a
situation later. Before that let see how the formula works using the above example.
CM % on our example of Sebastopol Cinema = UCM/USP
= Br 10/ Br 25
= 0.4
This can be interpreted as, units sold cover variables costs and contribute 40 percent to cover
fixed cost and increase in profit.
The break even sales amount (Birr) for Sebastopol Cinema = FC/CM%
= 48,000/0.40
= Br 120,000
The breakeven sales determined using equation method was a mere multiplication of the
breakeven point in unit and the unit selling price (4800 units x Br 25) which is exactly the same
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with what you determined using a more complicated contribution margin approach.
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 Why do you think using the contribution margin approach is essential?

Well, sometimes you will be given only the income statement and asked to determine the
breakeven sales without sufficient information about units selling price and unit variable cost. In
this case, only using the contribution margin ratio you can determine the breakeven point in sales
by dividing total fixed cost by CM ratio gives the break-even point in sales dollars.
For example, Jimma Electronics Co. produces portable radios. It has released the following
Variable Costing Income Statement. This is the only financial information that we have
regarding the company’s operations:
Sales Revenue--------- 100,000
Less Variable Costs------30,000
 Contribution Margin----- 70,000
Less Fixed Costs--------- 50,000
Operating Income ------- Br 20,000
What is the Break-Even point for Jimma Electronics Co? You do not know the number of units
that Jimma Electronics sold in a year. You do not also know the Price or the Variable Cost per
unit. Although you do not know the price or the Variable Cost per unit, you are still able to
calculate the Contribution Margin Ratio.
Contribution ratio can be determined by dividing total contribution margin to total sales.
CM% in this case is, therefore, determined as follows:
= Br 70,000 ÷ Br 100,000 or 1- variable cost ratio
= 0.7 0r 70% 1- (variable cost ÷ sales)
1-(30,000 ÷ 100,000)
0.7 Or 70%
The breakeven point in sales is also determined by dividing the total fixed cost by the
contribution margin ratio determined above as follows:
= FC/CM%
= 50,000/0.7
=Br 71,428.57
Keep in mind the reason that Jimma Electronics’ Sales Revenue is lower than it was before is
because the company sold fewer units. Keeping the price and Variable Cost per unit remained
unchanged. Let's check if Breaks Even at this Sales Revenue figure:
Sales Revenue: -------------------------------------- Br 71,428.57
Less Variable Costs (30% of 71,428.57) -------------- 21,428.57
Contribution Margin------------------------------------Br 50,000
Less Fixed Costs--------------------------------------------- 50,000
Operating Income -------------------------------------------- Br 0
1.3.1.3 Graphical Approach
You have seen how solutions to break-even problems are determined using an algebraic formula.
However, sometimes managers need information in more visual format, such as graphs. In this
approach you can construct a CVP graph by plotting total cost and total revenue graph at
different activity level. The breakeven point is found at the intersection point of total revenue and
total cost lines.
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The chart or graph is constructed as follows:

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1. Plot fixed costs, as a straight line parallel to the horizontal axis

2. Plot sales revenue and variable costs from the origin
3. Total costs represent fixed plus variable costs.
4. The breakeven point represents the intersection point of total revenue and total cost
lines
Now you can draw a CVP graph to Sebastopol Cinema following the steps given above and
locate the breakeven point.
 Birr Total Revenue Line
Operating Profit
Total Cost Line

Operating Loss

120,000
Total Variable Cost

48,000
Breakeven Point

Fixed Cost Line

Fixed Cost

4,800 Units

The
breakeven points for Sebastopol cinema can determined from the graph by identifying the level
of output and sales value where the total revenue and total cost line cross to each other. In the
case of Sebastopol cinema this happened when 4800 tickets are sold for birr 120,000 in which
both the unit and the Birr value are similar with what have been determined in the equation and
contribution margin approaches. The graphical approach is usually preferred by managers as it
can provide a detail insight of the cost volume and profit relationship pictorially.
Activities 4.3.1.3: What are the different approaches in solving problems in a CVP model?
1.3.2 Target Operating Income Analysis
Using CVP analysis managers can determine the total sales in unit and Birr/Dollar needed to
reach the target profit level. The computation of sales volume in unit and/ or in amount to attain
the targeted profit is similar with that of the break even analysis, except that the targeted profit is
more than offsetting the cost. For instance, the management of Sebastopol Cinema desires to get
Br 9000 profit for the coming month, instead of operating at breakeven point, how many tickets
must be sold? Managers want to answer this question to provide the necessary resource support
to attain the desired profit at already determined volume of activity. The analysis can be
performed using equation method or contribution margin approach on the basis of personal
preference.
See both the methods using the information given for Sebastopol Cinema to determine the target
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sales in unit and Birr to that enable the firm to earn the targeted profit of birr 9,000 cab be
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determined using the equation method and contribution margin method as follows:
Equation Method to Determine Contribution Margin Approach
(Target sales unit) (Target sales unit)
(SP x Q) - (VCU x Q) -FC= TOI Q = FC +TOI/ CMU
(25 x Q) – (15 x Q) - 48,000= 9000 Q = (48,000 + 9,000)/10
10Q= 57,000 Q= 5,700
Q= 5,700
Equation Method to Determine Contribution Margin Approach
(Target sales in birr) (Target sales in birr)
 TR= SP x Q Target Sales in Birr = (FC + TOI)/CM%
=25 x 5700 = (48,000 + 9000)/ 40%
= Br 142,500 = Birr 142, 500
Both the methods provided similar result that the cinema must sell 5,700 tickets at a total of Birr
142, 500 to meet its target profit goal of birr 9000.
 Here you can recognize that each ticket sales beyond the breakeven point
contributes to the firms operating income.
1.3.3 The Impact of Income Tax on CVP Analysis
Profit seeking enterprises must pay tax on their profit, meaning that target income figures are set
at high enough to cover the firm’s tax obligation to the government. The relationship between an
organization‘s before tax income and after tax income is expressed in the following formula:
After Tax income = Before Tax Income – Income Taxes
NIAT = NIBT- (NIBT x t)
= NIBT x (1-t)
Dividing both sides by (1-t) you can get:
NIAT/ (1-t) = NIBT
Which gives you the desired before tax income that will generate the desired after tax income,
given the company’s tax rate.
For instance, if the target profit given for Sebastopol Cinema above is expressed on after tax
basis and the firm is subject to a 40 percent income tax rate, what will be the required sales of
ticket in units and Birr? If you want to know how many units that you need to produce and sell in
order to generate a target Net Income (or after-tax profit), just convert the after-tax number into a
before-tax number.
NIBT = NIAT/ (1-t)
=Br 9000/ (1-0.4)
= Br 15,000
You can then substitute the before-tax profit figure in the formulas used in target operating
income analysis. The analysis of sales of tickets and amount of Sebastopol cinema to earn the
desired profit after tax can be determined using the equation and contribution margin approach as
shown on the following table:
Equation Method to Determine Contribution Margin Approach
(Target sales unit) (Target sales unit)
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(SP x Q) - (VCU x Q) -FC= TOIBT Q = FC +TOIBT/ CMU

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(25 x Q) – (15 x Q) - 48,000= 15,000 Q = (48,000 + 15,000)/10

10Q= 63,000 Q= 6,300
Q= 6,300
Equation Method to Determine Contribution Margin Approach
(Target sales in birr) (Target sales in birr)
TR= SP x Q Target Sales in Birr = (FC + TOIBT)/CM%
=25 x 6300 = (48,000 + 15,000)/40%
= Br 157,500 = Birr 157, 500

1.3.4 Sensitivity Analysis

The entire example above assumes a definite amount of certainty as far as knowledge or
assumptions of the cost structure and the sale price are concerned. However, in the real-world,
day to day problems may cause some or all of the information to change. The question to be
answered in this section is what if a change occurs in our assumption in the previous CVP
analysis? Obviously the analysis must be re-done.
Sensitivity analysis is a “what if” technique that managers use to examine how a result will
change if the original predicted data are not achieved or if an underlying assumption changes.
In the context of CVP analysis, sensitivity analysis answers the following questions:
 What will be the operating income if units sold decrease by 15% from original
prediction?
 What will be the operating income if variable cost per unit increases by 20%?
The sensitivity of operating income to various possible outcomes broadens the perspective of
management regarding what might actually occur before making cost commitments.
To make the concept clear let you take the Income statement of Sebastopol Cinema prepared
when the firm planned an operating profit of Birr 9000 from the sales of 5,700 tickets.
Sales Revenue :( Br25x5, 700) -------------------------------------- Br 142,500
Less Variable Costs (Br 15 x 5,700) -------------------------------------85,500
Contribution Margin----------------------------------------------------Br 57,000
Less Fixed Costs-------------------------------------------------------------48,000
Operating Income -------------------------------------------------------- Br 9,000
The management has different proposals that are assumed to increase the operating income. To
make decisions that have implication on the cost, volume and profit, the management needs to
conduct a sensitivity analysis. For example the following proposals are given:
The marketing manager proposed that increasing a monthly advertising budget by Birr 4000 may
result a Birr 13,000 increase on a monthly sales. This proposal, if implemented will change the
fixed cost as well as the volume of sales. As you all know total variable cost also varies with any
change in volume, therefore the proposed change also changes the variable cost as well. So
before accepting the proposal the general the manager needs to conduct a sensitivity analysis to
realize the ultimate result of changes on fixed cost, variable cost and sales on operating income.

(1) (2) (3) = (2)-(1)

Existing Plan Proposed Plan Difference
Sales Revenue Br 142,500 155,500 13,000
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Variable cost (5,700 x 15;

6220 x Br 15) 85,500 93,300 7,800
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Contribution Margin 57,000 62,200 5,200

Fixed Cost 48,000 52,000 4,000
Operating Income 9,000 10,200 1,200
As you can see from the above analysis a Birr 4000 increase in the advertising budget, which is a
fixed cost increased the number of ticket that the firm is selling using the existing plan from
5,600 to 6,220 as a result the sale revenue as well as the variable cost increased along with the
increased in sales volume. As the analysis revealed that the operating income can increased by
Birr 1,200, the manager can implement the proposed plan.
As you have seen on the example above, Sensitivity analysis allows us to accommodate for the
dynamic nature of organizational environments by adding in new information and adjusting our
planning accordingly.
1.3.5 Margin of Safety
The margin of safety is the excess of the budgeted or actual sales over the breakeven sales level.
This tells managers the margin between current sales and the breakeven point. In a sense margin
of safety indicates the risk of losing money that a company faces; that is the amount by which
sales can fall before the company is in the loss area. The margin of safety is determined using the
following formula:
Margin of Safety = Sales Volume - Breakeven Sales volume
(Actual or Budgeted)
As an example, conceder the case of Sebastopol Cinema, that planed to attain a Birr 9000 before
tax profit at a sales volume of 5700 units or Birr 142, 500. The breakeven point for this
company as determined on section 3 above is attained at the sales volume of 4,800 units or Birr
120,000. The margin of safety for this company is the difference between the budgeted sales and
the breakeven sales, which is 900 units (5,700unite -4,800). The margin of safety in terms of
sales value is also determined as Birr22, 500(Birr 142,500-Birr120, 000). The interpretation is
that, sales volume of Sebastopol can drop by 900 tickets or Birr 22,500 before the firm incurs a
loss, if all other things remain constant.
In practice the margin of safety is determined in sales amount (Birr) and as a percentage of
current sales. To determine the margin of safety in percentage the following formula can be
used:
Margin of Safety (%) = Margin of safety in Birr
Sales
For Sebastopol Cinema the margin of safety percentage is,
22,500/142,500
= 19.3%
Activities 5.3:
a) How can cost Volume profit (CVP) analysis be used by a company?
b) List and explain the three approaches to analyze CVP problems
c) Explain the following terms:
i. Contribution margin
ii. Breakeven point
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iii. Sensitivity analysis

iv. Margin of safety
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1.4 Multiple Product Company and Cost-Profit-Volume Analysis

Our illustration of CVP Analysis on the previous part of this unit assumes that the company has
only one product; however in real life, companies produce a range of products, not just one kind
as was assumed in the example above. In case when a company offers more than one product,
obviously different products will have different selling prices, variable costs per unit and, as a
result, different contribution margins and contribution margin ratios.
 Dear learners, Can CVP analysis help managers in a multi product companies
with complication of some CVP assumptions?
The answer is 'Yes’, you can perform the same similar analysis if you just obtain some data
about the product mix and the constant sales mix assumption discussed above holds true. The
term sales/revenue mix, which is essential in such a situation, is defined as the relative
proportions or combinations of quantities of products that comprise total sales.
In performing the analysis, first, you need to know proportion in which each of the products is
sold. Then you can calculate contribution margin for each product. After that you define
weighted average contribution margin, which is used in the determination of break-even point
or the amount of sales required to gain desired income (profit).
Let's illustrate it on Ethio.Tire Corporation an example. Assume, the company produces 3 types
of tire: for trucks, cars and motor-bikes. The following data is available:
  Truck Tire Car Tire Motor-bike
Tire
(A) Share in physical volume sold, % 30% 45% 25%
(B) Selling price per unit, Birr Birr10 Birr8 Birr7
(C) Variable cost per unit, Birr Birr7 Birr6 Birr5
(D) Contribution per unit, Birr (B - C) Birr3 Birr2 Birr2
(E) Contribution margin ratio (D ÷ B) 0.30 0.25 0.29
(F) Fixed costs total, Birr Birr10,000
From the given above you can calculate weighted average contribution margin. To calculate
weighted average contribution margin you need to "weight" the contribution margin per unit of
these three products and present it as "three-in-one". To state it in the form of formula:
Weighted Average Contribution Margin per Unit = CMU x Percentage of sales Mix
Using information given above you can calculate Weighted Average contribution margin as
follows:
Weighted Average Contribution Margin per Unit = (30% x Birr3) + (45% x Birr2) + (25% x Br
2) = Birr 2.3
Now break-even point may be calculated using the weighted average contribution margin as far
as the given sales mixes remain as it is.
1.4.1 Contribution Margin Technique and Break-even point for a Multiple Product
Company
The calculation of breakeven point in a multi-product company follows the same logic as in a
single product company. While the numerator will be the same fixed costs, the denominator now
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will be weighted average contribution margin. The modified formula is as follows:

Break-even Point (in units) =  Fixed Costs
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Weighted Average Contribution Margin per Unit

For our example break-even point (in units) for Ethio.Tire Corporation, can be determined using
the formula as,
BEP (in units) = FC/ WA.CM
=Br 10,000/2.3
Br 4347.86
The company will be at breakeven if it approximately produces 4,348 units. The total numbers
of outputs required to breakeven are then split in accordance with the proportion defined in row 1
in the above table:
 Truck tires: 4,348 units x 30% = 1,304 units
Car tires: 4,348 units x 45% = 1,957 units
Motor-bike tires: 4,348 units x 25% = 1,087 units
Ethio.Tire Corporation will be at break-even (i.e., will get neither profit nor loss) if it sells the
above volumes of Tires at the given proportion 30%:45%:25%.
However, it is important to remember that each proportion of product mix will have different
break-even points. For example, if market situation changes and Ethio.Tire Corporation switches
to larger production of more expensive truck tires with proportion 45%:30%:25%, break-even
point will change. In this case, the weighted average contribution margin per unit will be
Birr2.45 and zero profit will be earned at total level of sales of around 4,082 valves (compared to
4,348 units).
The change occurred due to the fact that contribution ratio per unit of truck tires is the highest
(Birr3 for truck tires versus Birr2 per car or motor-bike tires). Thus, more income can be
generated by producing and selling truck tires and break-even point is reached faster (with less
total items produced and sold).
 A shift in sales-mix from high-margin items to low-margin items can cause total
profit to decrease even though total sales may increase. Conversely, a shift in the
sales mix from low margin items to high margin items can cause the reverse
effect-total profit may increase even though total sales decrease.
Break-even point for multiple product production can be calculated in Birr value as well. Here
also, the numerator is the same fixed costs. The denominator now will be weighted average
contribution margin ratio. The modified formula is as follows:
Break-even Point (in Birr) =  Fixed Costs
Weighted Average Contribution Margin Ratio
Based on figures from the earlier table with information about three Tire types, the break-even
point will be reached at:
Break-even Point (in dollars) = Birr10,000
30% x 0.3 + 45% x 0.25 + 25% x 0.29 = Birr36,364
Therefore, to achieve the break-even point, Ethio.Tire Corporation has to sell tires for a total of
Birr36, 364 (valid only when proportion of sales is 30%:45%:25%).
Let's check the results: ∑Sales Units x Contribution - Fixed Costs, should approximately equal
zero (rounding difference may arise): Br3 x 1,304 + Br2 x 1,957 + Br2 x 1,087 - Br10, 000 = 0
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1.4.2 Contribution margin technique and sales required for desired income for a multi-
product company
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The logic to calculate sales required for designed income (profit) for a multi-product company is
the same as for a single product company. In the formula for determining the sales required for
desired profit, we just substitute contribution margin per unit for one product with weighted
average contribution margin for multiple products.
The formula to calculate the required unit sale for a given desired income is shown below:
Unit Sales = Fixed Costs + Profit
Weighted Average Contribution Margin per Unit
And the amount of sales in dollars can be determined using the following formula:
Sales (Birr) = Fixed Costs + Profit
 Contribution Margin Ratio
1.5 Not for Profit Organizations and Cost-Profit-Volume (CVP) Analysis
Managers in not-for-profit (NFP) organizations also routinely use CVP analysis to examine the
effect of activity and others short run changes on revenue and costs. For example, activity
administration must analyze the impact of increment in population on the different tax revenue
and the cost of providing services such as education, transportation, and police protection etc.
Mangers in diverse NFPs such as, universities, Public hospitals, and charitable and development
oriented nongovernmental organizations (NGOs) are also apply CVP as operational analysis
model. For instance Jimma University can use CVP in analyzing the change in student
population and its impact on the cost of service provision such as, cafeteria, library teaching,
tutorial, research guidance and the like.
Activity: Explain how do nonprofit organizations apply CVP model in their administrative
decisions?
Chapter Summary
Unit five presents the cost-volume-profit (CVP) analysis model and illustrates how managers use
that model in their profit planning and answer important “what-if” business questions. CVP
analysis helps management accountants alert managers to the risks and rewards of decisions they
are considering, by illustrating how the “bottom-line” is affected by changes in activity levels
and/or key pricing or cost components. CVP analysis is based on several assumptions, one of
which is that fixed costs can be distinguished from variable costs. However, whether a cost is
variable or fixed depends on the time period for the decision and also the range of activity
(relevant range) being considered. You were also presented with a method for applying CVP
analysis to a single product companies and companies with multiple products, and to the scenario
of NFP.
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