FINANCIAL ANALYSIS

CLASS 3 & 4

SESSION PLAN
COST-VOLUME-PROFIT ANALYSIS
BREAK-EVEN ANALYSIS

CVP ANALYSIS
The cost-volume-profit (CVP) analysis is a tool to show the relationship between various ingredients of profit planning, namely 1. Unit sales price (SP)
2. Unit variable cost (VC) 3. Fixed costs (FC) 4. Sales volume, and

5. Sales-mix (in the case of multi-product firms).

BREAK-EVEN POINT
The crucial step in CVP analysis is the determination of the break-even point (BEP)

BEP is defined as the sales level at which the total revenues equal total costs. It is the level at which losses cease and beyond which profit starts.

Contribution Margin (CM) Approach

Example 1: How many ice-creams, having a unit cost of Rs 2 and a selling price of Rs 3, must a vendor sell in a fair to recover the Rs 800 fees paid by him for getting a selling stall and additional cost of Rs 400 to install the stall? Contribution Margin (CM) = Sales Price Unit Variable cost BEP (units) = Fixed Costs / CM per unit BEP (units) = (800 + 400) / (3 2) = 1200 / 1 = 1200 units BEP (amount or sales revenue) = BESR = BEP(units) x Sales price per unit = 1200 units x 3/- per unit = Rs 3600/-

CONTINUED
Profit to Volume (P/V) Ratio=CM(unit) / SP(unit)= 1/3 = 33.33% BEP (amount) is also given by = Fixed Cost / PV ratio = 1200 / 1/3 = 3600/VC to Sales Volume (V/V) ratio = 1 P/V ratio = 1 1/3 = 2/3 = 66.67%

Or P/V ratio + V/V ratio always equals 1 or 100 %

MARGIN OF SAFETY
Margin of safety (MS) = excess of actual sales revenue (ASR) over break-even sales revenue (BESR) = ASR BESR

MS Ratio = (ASR-BESR) / ASR = MS(amount) / ASR If in the vendors case, actual sales is 2,000 units (Rs 6,000) MS (units) = 2000 1200 = 800 units MS (amount) = Rs 6,000 Rs 3,600 = Rs 2,400 & the MS ratio is Rs 2,400 Rs 6,000 = 40 per cent.

PROFIT
The amount of profit can also be directly determined with reference to the margin of safety and P/V ratio as follows :-

Profit = MS(amount) x PV Ratio , or Profit = MS(units) x CM per unit In the vendors case, profit = Rs 2,400 33.33 % = Rs 800
or 800 Re 1 = Rs 800 This is because once the total amount of fixed costs has been recovered, profits will be the difference of additional sales revenue (ie MS) and variable costs.

SALES REVENUE FOR DESIRED PROFIT

BEP(amount) = FC / PV ratio which means that BESR covers total FC & Profit is zero. So sales revenue for a desired profit level will be :(Desired profit + FC) / PV ratio If in the vendors case, desired profit is Rs 1000/- , he will need a sales revenue of (1000 + 1200) / 33.33% = Rs6600/or 2200 units @ Rs 3/- each

Break-Even Applications

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RECAP
1. C-V-P Analysis 2. Break Even Point 3. Contribution Margin 4. Margin of Safety 5. Profit calculations 6. Revenues for desired profits

NEXT SESSION
1. Changes in Financial Position 2. Understanding Non Cash Expenses
3. Understanding Cash Flow Concepts 4. Preparation of Cash flow statements

THANK YOU