Break-Even Point and Cost-Volume-Profit Analysis

Chapter 3
BREAK-EVEN POINT AND

COST-VOLUME-PROFIT
ANALYSIS
MA. Le Hoang Oanh
QUESTIONS ADDRESSED BY
COST-VOLUME-PROFIT ANALYSIS
CVP analysis is used to answer questions

such as:
§ How much must I sell to earn my desired income?
§ How will income be affected
if I reduce selling prices to
increase sales volume?
§ What will happen to
profitability if I expand
capacity?
1
LEARNING OBJECTIVES
Understanding basic concepts in cost-volume-profit

relationships:
Relationships between volume and profit (contribution margin)
Relationships between sales and profit (contribution margin
ratio)
Relationships between sales growth rate and profit growth
rate (operating leverage)
Applying C-V-P relationships to decision making
(Show the effects on contribution margin of changes in
variable costs, fixed costs, selling price and volume)
LEARNING OBJECTIVES
Compute the break-even point

Use the C-V-P formulas to determine the activity level
needed to achieve a desired target net profit figure
access safety in business (margin of safety, margin
of safety percentage)
Effects of shifts in the sales mix on contribution margin
and the break-even point
Assumptions of CVP analysis
2
CONTENTS
Basic concepts in CVP relationships

Applying CVP relationships to decision making
Break-even analysis
Sales mix analysis
Assumptions of CVP analysis
BASIC CONCEPTS IN CVP

RELATIONSHIPS
3
BASIC CONCEPTS IN CVP RELATIONSHIPS
Contribution margin
Contribution margin ratio
Cost structure
Operating leverage
CONTRIBUTION MARGIN
Contribution margin = Sales – Variable costs
CM is used first to cover fixed costs. Any remaining CM

contributes to net operating income.
Example 1:
Pringle Company manufactures and sells a single product.

Prepare the contribution income statement under the
following information in December 2008:
- Units sold: 500 - unit selling price: 40
- variable costs per unit: 24 - Total fixed costs: 4,000
4
CONTRIBUTION MARGIN
Pringle company
Contribution Income statement
For the month of December 2008
Total Per unit

Sales
(-) Variable costs
Contribution margin
(-) Fixed costs
Contribution margin per unit =
Net income incremental (decremental) operating
income when selling one more (less) 1
unit of product (fixed costs
unchanged)
Incremental (decremental) CM = units sold

CONTRIBUTION MARGIN more (less) * CM per unit (unit selling price,
variable costs per unit unchanged)
Number of units sold

0 1 2 250 251 400 500
Sales 80 10,000 10,040 16,000 20,000
VC 48 6,000 6,024 9,600 12,000
CM 32 4,000 4,016 6,400 8,000
FC 4,000 4,000 4,000 4,000 4,000
Op.Income (3,968) 0 16 2,400 4,000
Incremental 16 16 2,384 1,600
Op.income
Incremental (decremental) operating

income = incremental (decremental)
CM (FC unchanged)
5
CONTRIBUTION MARGIN
Profit = CM of units above the break-even point
Loss = CM of units below the break-even point (units which needs to be
sold to break-even point
Number of units sold

0 1 2 250 251 400 500
Sales 0 40 80 10,000 10,040 16,000 20,000
VC 0 24 48 6,000 6,024 9,600 12,000
CM 0 16 32 4,000 4,016 6.400 8,000
FC 4000 4,000 4,000 4,000 4,000 4,000 4,000
Op.Income (4000) (3,984) (3,968) 0 16 2,400 4,000
Loss = units below the break- Profit = units above the break-
even point * CM per unit even point * CM per unit
CM reflects relationships between volume and profit à managers can quickly

determine operating income
CONTRIBUTION MARGIN
Continue Example 1:
Pringle estimate number of units sold increases by
30% in Jan 2009, estimate operating income if unit
selling price, variable exp per unit and fixed costs are
unchanged.
6
CONTRIBUTION MARGIN
CONTRIBUTION MARGIN
Disadvantages:
In multiple products company, managers can easily

confuse “Increasing sales of products with high
contribution margin per unit, net operating income will
higher” à wrongly decision making.
7
CONTRIBUTION MARGIN RATIO
Total CM
CM Ratio =
Total sales
CM per unit
CM Ratio =
Unit selling price
Unit selling price, VC per unit unchanged
Incremental Incremental x CM ratio

=
(decremental) CM (decremental) sales
FC unchanged
Incremental = Incremental
(decremental) operating income (decremental) CM
CM ratio reflect relationships between sales and profit

managers can quickly determine operating income
8
Continue Exp 1
Estimated sales in 1/2009 is 25,000. Estimated
operating income?
9
Useful analyzing instrument in decision making à if

increasing in the same sales, products with high CM
ratio can obtain a higher increase in operating income.
COST STRUCTURE
Cost structure refers to the relative proportion of fixed and
variable costs in an organization
Example 2: Company A, B & C have contribution income
statements in 08/2008
Company A Company B Company C
Total % Total % Total %

Sales 100,000 100% 100,000 100% 100,000 100
%
VC 15,000 15% 80,000 80% 95,000 95%
CM 85,000 85% 20,000 20% 5,000 5%
FC 80,000 15,000 0
Operating 5,000 5,000 5,000
Income
10
COST STRUCTURE
Supposing sales increases by 50.000 in each of these

companies, other information unchanged. Compute their
income.
COST STRUCTURE
Solution
Company A
11
COST STRUCTURE
Solution
Company A
Com A’s rapid

growth
% fixed costs (A) > (B) > (C)

Company B Increasing in the same sales
Incremental OI = 50,000 * 20% = 10,000 Percent increase in profit of
OI new = 5,000 + 10,000 = 15,000 (A) > (B) > (C)
Company C
Incremental OI = 50,000 * 5% = 2,500
OI new = 5,000 + 2,500 = 7,500
COST STRUCTURE
Supposing sales decreases by 20.000 in each of these

companies, other information unchanged. Compute their
income.
12
COST STRUCTURE
Solution
Company A
COST STRUCTURE
Solution
Company A % fixed exp of
(A) > (B) > (C)
Decreasing in the
same sales
Company B
Percent decrease in
Decremental OI = 20,000 * 20% = 4,000 profit of (A) > (B) >
OI new = 5,000 – 4,000 = 1,000 (C)
Company C
Company A’s losses
Decremental OI = 20,000 * 5% = 1,000 is biggest
OI new = 5,000 – 1,000 = 4,000
13
COST STRUCTURE
There are advantages and disadvantages to high fixed
cost (or low variable cost) and low fixed cost (or high
variable cost) structures.
An advantage of a high fixed

cost structure is that income A disadvantage of a high fixed
will be higher in good years cost structure is that income
compared to companies will be lower in bad years
with lower proportion of compared to companies
fixed costs. with lower proportion of
fixed costs.
Companies with low fixed cost structures enjoy greater

stability in income across good and bad years
OPERATING LEVERAGE
A measure of how sensitive net operating income is

to percentage changes in sales.
Percentage changes in
Degree of net operating income
Operating = >1
Percentage changes in
leverage
sales
How a percentage change in sales volume will affect profits.
14
OPERATING LEVERAGE
The degree of operating leverage at a given level of sales is
computed by following formula
Degree of Operating Contribution margin

=
leverage Net operating income
Operating leverage is a measure of the extent to which fixed costs
are being used in an organization and its effects on change in sales
due to change in net operating income
High fixed cost structure à high CM ratio à income will be very

sensitive to changes in sales (high Operating Leverage)
Low fixed cost structure à low CM ratio à income will be less

sensitive to percentage changes in sales (low Op.Leverage)
OPERATING LEVERAGE
Example 3:
Continue Exp 2, with requirements as follows:
1. What is the degree of operating leverage in each

company? What does it mean?
2. Compute again operating income of each company in 2

situations: sales increases by 50,000 and decreases by
20,000.
15
OPERATING LEVERAGE
1. OL (A) = 85.000 / 5.000 = 17
OL (B) = 20.000 / 5.000 = 4
OL (C) = 5.000 / 5.000 = 1
Meaning:
Degree of OL (A) = 17: with unit selling price, unit variable

exp and fixed exp are unchanged, sales increase
(decrease) by 1%, net income increases (decrease) by
17% in company A
OPERATING LEVERAGE
2. Sales increases by 50,000
16
OPERATING LEVERAGE
Company A
OPERATING LEVERAGE
2. Sales increases by 50,000
Company A
Company B
Incremental OI = 4* 50% = 200% or 5,000 * 200% = 10,000
OI new = 5,000 + 10,000 = 15,000
Company C
Incremental OI = 1 * 50% = 50% or 5,000 * 50% = 2,500
OI new = 5,000 + 2,500 = 7,500
17
OPERATING LEVERAGE
2. Sales decreases by 20,000
OPERATING LEVERAGE
Company A
18
OPERATING LEVERAGE
2. Sales decreases by 20,000

Company A
Company B
Decremental OI = 4* 20% = 80% or 5,000* 80% = 4,000
OI new = 5,000 – 4,000 = 1,000
Company C
Decremental OI = 1 * 20% = 20% or 5,000 * 20% = 1,000
OI new = 5,000 – 1,000 = 4,000
Same results to Ex 2 à quickly estimate what impact various
percentage changes in sales will have on profits
Quickly estimate percentage changes in sales to obtain target profits
OPERATING LEVERAGE
The degree of operating leverage is different at

different level of sales
Units sold = 0 à OL = 0
0 < Units sold < BEP à OL < 0 (OL reflects percent

decrease in loss with 1% increase in sales).
Units sold > Break-even point à OL > 0 and will be

decreased to 1 the father the company moves from its
BEP.
19
OPERATING LEVERAGE
Example 4:
Company D has information as follows
- Unit selling price: 30
- Unit VC: 20
- Total FC: 20,000
Requirement: Compute degree of operating leverage at

given number of units sold: 0 unit 1,000 units, 1,500 units,
2,000 units, 2,500 units, 3,000 units and 6,000 units.
OPERATING LEVERAGE
Solution
0 1,000 1,500 2,000 2,500 3,000 6,000
Sales 45,000 60,000 75,000 90,000 180,000
VC 30,000 40,000 50,000 60,000 120,000
CM 15,000 20,000 25,000 30,000 60,000
FC 20,000 20,000 20,000 20,000 20,000
OI -5,000 0 5,000 10,000 40,000
OL -3 ∞ 5 3 1.5
20
APPLYING CVP RELATIONSHIPS
TO DECISION MAKING
APPLYING CVP RELATIONSHIPS TO DECISION MAKING

Keep current business plan? Or: Economically,
choosing a plan
§ Change in fixed costs and sales
which has a change
volume? in CM is bigger than
§ Change in variable costs and sales a change in fixed
volume? costs
§ Change in fixed costs, sales price and
Analyzing method:
sales volume?
Step 1: Compute
§ Change in fixed costs, variable costs change in CM
and sales volume? Step 2: Compute
change in fixed costs
§ Change in fixed costs, variable costs,
Step 3: Compare
sales price and sales volume? change in CM and
§ Change in regular sales price change in Fixed costs
21
APPLYING CVP RELATIONSHIPS TO DECISION MAKING
Example 5:
Enfa Company
Contribution income statement
For the month of may, 2008
Total Per unit Percent

Sales 150,000 150 100%
(-) Variable costs 60,000 60 40%
Contribution margin 90,000 90 60%
(-) Fixed costs 50,000
Net operating income 40,000
CHANGE IN FIXED COSTS AND SALES VOLUME
Manager is contemplating a $20,000 increase in the

monthly advertising budget which would increase monthly
units sold by 30%. Would you recommend that the
advertising campaign be undertaken?
22
Solution:
Based on contribution margin per unit
Based on CM margin
23
• Based on operating leverage
CHANGE IN VARIABLE COSTS AND SALES VOLUME
Management is contemplating
the use of lower-quality raw
materials, which would save
$10/unit. However, the sales
manager predicts that using
lower-quality raw materials lead to
lower-quality products which
would decrease number of unitts
sold by 20%. Would you
recommend the use of the lower-
quality raw materials?
24
CHANGE IN VARIABLE COSTS AND SALES VOLUME
Solution:
CHANGE IN VAR. COSTS, SALES PRICE AND SALES VOLUME
To increase sales, the sales manager would like to cut

the selling price by $10/unit and increase the advertising
budget from $5.000 to $10.000 per month. The sales
manager argues that these two steps are taken, unit sales
will increase by 30%. Should the changes be made?
25
CHANGE IN VAR. COSTS, SALES PRICE AND SALES VOLUME
CHANGE IN FIXED COSTS, VAR. COSTS, & SALES

VOLUME
The sales manager would like to place the sales staff

on a commission basis of $20/unit sold, rather than on
flat salaries that now total $20,000 per month. The sales
manager is confident that the change will increase
monthly sales to 1,200 units. Should the change be
made?
26
CHANGE IN FIXED COSTS, VAR. COSTS, & SALES
VOLUME
CHANGE IN FIXED COSTS, VAR. COSTS,

SALES PRICE & SALES VOLUME
The sales manager would like to place the sales staff

on a commission basis of $20/unit sold, rather than on
flat salaries that now total $20,000 per month. He also
would like to cut the selling price by $8/unit. The sales
manager is confident that the change will increase
monthly unit sales by 40%. Should the change be made?
27
CHANGE IN FIXED COSTS, VAR. COSTS,
SALES PRICE & SALES VOLUME
CHANGE IN REGULAR SALES PRICE

Suppose Enfa sold 1,000 units (regular unit sales) and
still has excessive capacity. Enfa has an opportunity to
sell 300 units to a wholesaler if the price can be reduced
by 20%. Enfa has to delivery to their door. Shipping costs
is estimated to be $4.800. What price would be quoted
to the wholesaler if Enfa wants to increase its monthly
profits by $5,400? Should this deal be made?
28
CHANGE IN REGULAR SALES PRICE
BREAK-EVEN ANALYSIS
29
BREAK-EVEN ANALYSIS
Break-even point computations

CVP Relationship in Graphic form
Target net profit analysis
The margin of safety
BREAK-EVEN POINT COMPUTATIONS
At break-even point:
Total sales = Total costs
(Total Contribution margin = Total fixed costs)
pxBE = axBE + b
with p: sales price
xBE: Break-even point in units sold
a: unit variable cost
b: total fixed costs
30
Formula for the break-even point in unit sales and sales dollars.
In single product company xBE = b / (p – a)
Break-even point Total fixed costs

in unit sales (a1)
= Unit sale price – unit var.cost
Total fixed costs

or = (a2)
Unit contribution margin
Break-even point in sales dollars

or = (a3)
Unit Sales price
pxBE = b / [(p – a)/p]
Break-even point Total fixed costs (b1)

=
in sales dollars Contribution margin ratio
(b2)
Total fixed costs
or =
1 – variable costs/sales
(b3)
or = Break-even point in unit
sales * unit sales price
31
In multiple product company:
Step 1: Compute company’s break-even point in

sales dollars: using formula b1 or b2
Step 2: Compute break-even point in sales dollars of

each product = company’s break-even point
in sales dollars * % sales of each product.
Step 3: Compute break-even point in unit sales of

each product: using formula a3

BREAK EVEN POINT GRAPH
Sales and Exp
y = px
y
Break-even Profit y = ax + b
point area
Break-even point
in sales dollars
y = ax
Loss y=b
area
Break-even point
in unit sales x
Volume 64
32
y NET OPERATING INCOME’S GRAPH

Profit or
loss
y = (p – a) x – b
Break-even
point
Profit
area x
Loss Volume
area
-b
Example 6:
Company F which produces and sells 2 products, including A and
B has income statement as follows:
Product A Product B Company

Total Per unit Total Per unit Total
Sales 40,000 20 60,000 15 100,000
VC 20,000 10 12,000 3 32,000
CM 20,000 10 48,000 12 68,000
FC 40,800
Net O.I 27,200
Compute break-even point in unit sales and in sales

dollars of each product.
33
TARGET NET PROFIT ANALYSIS
Contribution margin = Fixed costs + Profit

(Sales = Variable costs + Fixed costs + Profit)
(p – a)x = b + P
with p: unit sales price

x: unit sales to attain the target profit
a: variable costs per unit
b: total fixed costs This image
cannot
P: target profit currently
be
34
In single product company

x = (b + P)/ (p – a)
Unit sales Fixed costs + target net profit

to attain = Unit selling price – Unit variable (c1)
the net costs
target profit
or Fixed costs + target net profit (c2)

=
Contribution margin per unit
Sales to attain the net target profit (c3)

or =
Unit sales price

px =(b + P)/ [(p – a)/p]
Sales to attain Fixed costs + Target net profit

the target = (d1)
Contribution margin ratio
profit
Fixed costs + Target net profit (d2)

or =
1 – variable costs/sales
or = Unit sales to attain the target (d3)

profit * unit sales price
35
In multi product company
Step 1: Compute Company’s Sales to attain target

net profit: Using formula d1 or d2
Step 2: Compute Sales to attain target net profit of

each product = Company’s Sales to attain
target net profit * % sales of each product.
Step 3: Compute unit sales to attain target net profit

of each product: using formula c3

Example 6:
Binh Minh Company a) Compute
Contribution income statement sales in unit
For the month of Jan, 2008 and sales in
dollars to attain
Total Per unit %
net profit of
Sales 500,000 1,000 100%
$150,000 in
(-) Variable costs 300,000 600 60%
Freb, 2008
Contribution margin 200,000 400 40%
(-) Fixed costs 80,000
Net operating income 120,000
b) Suppose in Feb 2008, Applying new strategy, sales officer

will get a commission of 100 per unit above break-even point
rework question a.
36
MARGIN OF SAFETY
The margin of safety is the excess of budgeted (or

actual) sales over the breake-even sales
Margin of safety = Total sales – Break-even sales
Margin of safety Margin of safety

= x 100%
percentage Total sales
37
MARGIN OF SAFETY
Company X Company Y
Total % Total %
Sales 500,000 100% 500,000 100%
Variable costs 70% 40%
CM 30% 60%
Fixed costs 90,000 240,000
Profit
Break-even point
in sales dollars
Margin of safety
% Margin of
safety
MARGIN OF SAFETY
Company X Company Y
Total % Total %
Sales 500,000 100% 500,000 100%
Variable costs 350,000 70% 200,000 40%
CM 150,000 30% 300,000 60%
Fixed costs 90,000 240,000
Profit 60,000 60,000
BE point in sales dollars 300,000 400,000
Margin of safety 200,000 100,000
Margin of safety percentage 40% 20%
Company Y has ……… fixed costs structure à …...…… CM ratio ->
……………. margin of safety
In Company ..……, if Sales is reduced, profit is significantly……………
Specifically, if its sales is reduced by $….…….., it gets break-even point ; while
Company ……., to have zero in operating income, sales is decreased by
$………….
38
SALES MIX ANALYSIS
SALES MIX ANALYSIS
Concept of sales mix

Average Contribution margin ratio
Choosing an appropriate sales mix
39
SALES MIX ANALYSIS
Sales mix is the relative proportion in which a
company’s products are sold
Exp 6: Company F which produces and sells 2 products, including A

and B has income statement as follows:
Product A Product B Compan
y
Total % Total % Total
Sales 60,000 100% 40,000 100% 100,000
Var. costs 30,000 50% 8,000 20% 38,000
CM 30,000 50% 32,000 80% 62,000
Fixed costs 40,800
Net O.Income 21,200
Sales mix: + Product A: ……….. + Product B: …………..
AVERAGE CONTRIBUTION MARGIN RATIO
n
∑ CM of product i
Average CM ratio = i=1
n
∑ Sales of product i
i=1
Total company’s CM
= Total company’s
sales
n
or = ∑ (CM ratio of product i x % sales of product i)

i=1
40
AVERAGE CM RATIO, CHOOSING AN
APPROPRIATE SALES MIX
Product A Product B Total

CM ratio
% Sales
Average CM ratio

Sales 60,000 100% 40,000 100% 100,000
Var. costs 30,000 50% 8,000 20% 38,000
CM 30,000 50% 32,000 80% 62,000
Fixed costs 40,800
Net O.Income 21,200
Break even sales
Margin of safety
AVERAGE CM RATIO, CHOOSING AN APPROPRIATE

SALES MIX
Product A Product B Total

CM ratio
% Sales 40% 60% 100%
Average CM ratio
Sales
Var. costs
CM
Fixed costs
Net O.Income
Break even sales
Margin of safety
41
CHOOSING AN APPROPRIATE SALES MIX
Increasing % sales of products with high CM ratio
Average CM ratio is increased
B-E sales is Net income is Mar. of safety

reduced increased is increased
Next period, products with higher CM ratio should come

high on the list of priorities
ASSUMPTIONS OF CVP
ANALYSIS
42
Assumptions of CVP Analysis
$ $
Price Total
per Cost
Unit
Volume Volume
Selling Price is Constant Variable Cost Per Unit is
Constant
Total
Fixed SUVs Car
Costs
2:1
Volume
Fixed Costs are Constant Sales Mix is Constant
43
Units Units
Produced Sold
End of Chapter 3
44

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Chapter 3

BREAK-EVEN POINT AND

CVP analysis is used to answer questions

Understanding basic concepts in cost-volume-profit

Compute the break-even point

Basic concepts in CVP relationships

BASIC CONCEPTS IN CVP

Contribution margin = Sales – Variable costs

CM is used first to cover fixed costs. Any remaining CM

Pringle Company manufactures and sells a single product.

- Units sold: 500 - unit selling price: 40

- variable costs per unit: 24 - Total fixed costs: 4,000

Total Per unit

Incremental (decremental) CM = units sold

Number of units sold

Incremental (decremental) operating

Number of units sold

CM reflects relationships between volume and profit à managers can quickly

In multiple products company, managers can easily

Unit selling price, VC per unit unchanged

Incremental Incremental x CM ratio

CONTRIBUTION MARGIN RATIO

CM ratio reflect relationships between sales and profit

CONTRIBUTION MARGIN RATIO

Useful analyzing instrument in decision making à if

Company A Company B Company C

Total % Total % Total %

Supposing sales increases by 50.000 in each of these

Com A’s rapid

% fixed costs (A) > (B) > (C)

Supposing sales decreases by 20.000 in each of these

An advantage of a high fixed

Companies with low fixed cost structures enjoy greater

A measure of how sensitive net operating income is

How a percentage change in sales volume will affect profits.

Degree of Operating Contribution margin

High fixed cost structure à high CM ratio à income will be very

Low fixed cost structure à low CM ratio à income will be less

Continue Exp 2, with requirements as follows:

1. What is the degree of operating leverage in each

2. Compute again operating income of each company in 2

1. OL (A) = 85.000 / 5.000 = 17

OL (B) = 20.000 / 5.000 = 4

OL (C) = 5.000 / 5.000 = 1

Degree of OL (A) = 17: with unit selling price, unit variable

2. Sales decreases by 20,000

2. Sales decreases by 20,000

The degree of operating leverage is different at

0 < Units sold < BEP à OL < 0 (OL reflects percent

Units sold > Break-even point à OL > 0 and will be

Company D has information as follows

- Unit selling price: 30

- Total FC: 20,000

Requirement: Compute degree of operating leverage at

APPLYING CVP RELATIONSHIPS TO DECISION MAKING

Total Per unit Percent

CHANGE IN FIXED COSTS AND SALES VOLUME

Manager is contemplating a $20,000 increase in the

CHANGE IN FIXED COSTS AND SALES VOLUME