Applications of Cost-Volume Profit (CVP) Analysis

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on June 22, 2021

CVP relationships information which is useful to managers in a wide variety of planning decisions. Managers use this analytical technique to accomplish far more than just the determination of a break-even point.

Example

The following problems are based on the information given for company X:
S.P (Sales Price) per unit = $25
Variable Cost per unit = $15
Fixed costs for related time period = $30,000
Total sales made by Company X are $100,000.
1). A 10% reduction in selling price per unit.

Solution:

New S.P. per unit = 25 – (25 x 10%) = $22.50
New Contribution margin per unit = 22.50 – 15 = $7.50
With fixed costs remaining unchanged, the new B.E point is:
= 30,000 / 7.5 = 4,000 units
The management may find the proposed changes desirable if, in the long run, sales are expected to increase.
2). The management believes that with a 10% reduction in selling price per unit, demand is expected to increase by 25%. What effect would this change have on profits? Is this a viable proposition?

Sales 1,00,000 (4,000 @ $25)
Variable Costs (4,000 @ $15) 60,000
Contribution Margin 40,000
Fixed Costs 30,000
Net Profit 10,000
B.E point 3,000 units
B.E sales $75,000
P/V ratio 40%
MOS Ratio 25%

With a reduction in Sales Price per unit and an increase in Sales by 25%, the relevant calculations are shown below:
New S.P. per unit = $22.50
Sales = 5,000 units
Changed Situation
Sales (5,000 @ 22.50) = $1,12,500
Variable Costs (5,000 @ 15) = 75,000
Contribution Margin = 37,500
Fixed Costs = 30,000
Net Profit = 7,500
B.E point = 4,000 units
B.E sales revenue = 90,000
P/V Ratio = 33.33%
MOS ratio = 20%
The proposed change is not desirable as net profits have decreased by $2,500, B.E point has increased to 4,000 units and bot P/V ratio and MOS ratio have also decreased.
Hence these examples serve to demonstrate that cost-volume-profit analysis can be used to solve a variety of business problems. It is a powerful tool that is used in conjunction with variable costing in order to improve the decision-making process.
 

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