CVP or Breakeven Analysis
» CVP analysis: definition, advantages and disadvantages
Page: 2 - 3
» Contribution, Contribution ratio and Variable cost ratio
Page: 3 - 6
» Expected sales quantity and Expected sales amount
Page: 7 - 12
» Breakeven Point
Page: 12 - 16
» Margin of Safety
Page: 16 - 18
» Limiting factor analysis
Page: 19 - 39
» Make or buy decision
Page: 40 - 43
,In this chapter we shall discuss about Breakeven or Cost-Volume-Profit (CVP) Analysis. This
chapter is important not only for Management Accounting exam, but also for practical workplace.
CVP analysis (cost-volume-profit) or breakeven analysis refers to determining interrelationships
between cost, quantity and profit at different activity levels. CVP analysis includes a number of
tools; such as: contribution margin analysis, breakeven point, margin of safety, limiting factor
analysis, make or buy decision etc.
Advantages / benefits / importance of CVP or breakeven analysis:
1. CVP analysis helps to know how much money is left for paying fixed costs (i.e. contribution).
2. CVP analysis helps to know how much profit may be earned from a certain sales volume at a
certain selling price.
3. CVP analysis helps to know the expected selling price and the expected sales quantity for
making a certain profit figure.
4. CVP analysis helps to know the impact of changes in selling price and in sales quantity on profit.
5. CVP analysis is used for fixing sales incentive, sales target, production priority etc.
6. CVP analysis helps to know the required production volume for recovering all costs and thus
for avoiding any loss (i.e. breakeven point).
7. CVP analysis can demonstrate its results in several forms; such as: monetary amount basis, per
unit basis, graphical basis and percentage basis.
8. CVP analysis shows how much of the sales volume is left for profit, after recovering all expenses
(i.e. margin of safety). This enables the company to decide price cuts, sales promotion etc.
9. CVP analysis is used to assess if costs are too high for the business to be successful.
10. CVP analysis is used to decide if certain product is worth launching in the market or not.
Criticisms / assumptions / limitations / disadvantages / weaknesses of CVP or breakeven analysis:
1. CVP analysis requires to classify all costs between fixed cost and variable cost. But all mixed
costs may not be accurately classifiable in this manner.
2. Selling price per unit is assumed here to remain the same at any level of output. But selling
price may decrease in case of a large sales volume (i.e. trade discount).
Page 2 of 43
,3. Variable cost per unit is assumed here to remain the same at any level of output. But variable
cost per unit (such as: labor hour rate or materials price) may increase in case of excessive
production volume, due to shortage of inputs.
4. Fixed cost is assumed here to remain the same at any level of output. But in practice fixed cost
increases beyond the relevant range.
5. CVP analysis ignores variation in machine productivity and labor efficiency.
6. CVP analysis ignores any uncertainty in estimating selling price, sales volume, variable cost
and fixed cost etc.
7. CVP analysis is applicable only to a single product or a single product mix.
8. CVP analysis often assumes that all the produced quantity can be sold in the market.
9. As any other management accounting tool, CVP analysis ignores sunk costs.
10. CVP analysis is absolutely a quantitative technique and ignores any qualitative consideration.
֍֍֍ ֍֍֍ ֍֍֍
The very basics of CVP or breakeven analysis is Contribution. This is a common word in our daily
life, although the sense it makes in Management Accounting is a bit different.
Contribution refers to the excess of sales revenue over the variable cost of production, thus the
amount remaining for net profit after recovering fixed cost.
Contribution in $ = Total sales – Total variable cost = Fixed cost + Profit
= (Selling price per unit – Variable cost per unit) × Number of units sold
= Contribution per unit × Number of units sold
If in your exam you are asked to write the definition, you must put the formula also, without saying.
To understand easier: Sales = Total cost + Profit = Fixed cost + Variable cost + Profit
Contribution in $ = Sales – Variable cost = Fixed cost + Profit
Here we clearly mention “in $” because contribution is also expressed per unit and in percentage.
Page 3 of 43
, Contribution in $
Contribution per unit = Selling price per unit – Variable cost per unit =
Number of units sold
Contribution per unit Contribution in $
Contribution ratio = × 100 = × 100 = 100% – Variable cost ratio
Selling price per unit Total sales
Variable cost per unit Total variable cost
Variable cost ratio = × 100 = × 100 = 100% – Contribution ratio
Selling price per unit Total sales
Variable cost ratio + Variable profit ratio = 100%
All the formulas are the different forms of the same thing and are corollary to each other, so perhaps
not difficult to remember.
As you understand, 100 is multiplied at the end for expressing in percentage.
Contribution ratio is also known as profit-volume (P/V) ratio, variable profit ratio, marginal income
ratio etc. On the other hand, contribution in $ is also known as contribution margin.
Illustration # 1: Sales is 10,000 units @ $10. Variable cost is $3 per unit. Find out: (i) Contribution
margin; (ii) Contribution per unit; (iii) Variable profit ratio; and (iv) Variable cost ratio.
Solution: Contribution margin = Total sales – Total variable cost = (10,000 units sold × $10 selling
price per unit) – (10,000 units sold × $3 variable cost per unit) = $70,000
Alternatively: Contribution margin = (Selling price per unit – Variable cost per unit) × Number of
units sold = ($10 – $3) × 10,000 units = $70,000
Contribution per unit = Selling price per unit – Variable cost per unit = $10 – $3 = $7
Contribution in $ $70,000
Alternatively: Contribution per unit = = = $7
Number of units sold 10,000 units
Contribution per unit
Variable profit or Contribution ratio = × 100 = $7 ÷ $10 × 100 = 70%
Selling price per unit
Contribution in $
Alternatively: Variable profit ratio = × 100
Total sales
$70,000
= × 100 = 70%
10,000 units sold × $10 selling price per unit
Page 4 of 43
» CVP analysis: definition, advantages and disadvantages
Page: 2 - 3
» Contribution, Contribution ratio and Variable cost ratio
Page: 3 - 6
» Expected sales quantity and Expected sales amount
Page: 7 - 12
» Breakeven Point
Page: 12 - 16
» Margin of Safety
Page: 16 - 18
» Limiting factor analysis
Page: 19 - 39
» Make or buy decision
Page: 40 - 43
,In this chapter we shall discuss about Breakeven or Cost-Volume-Profit (CVP) Analysis. This
chapter is important not only for Management Accounting exam, but also for practical workplace.
CVP analysis (cost-volume-profit) or breakeven analysis refers to determining interrelationships
between cost, quantity and profit at different activity levels. CVP analysis includes a number of
tools; such as: contribution margin analysis, breakeven point, margin of safety, limiting factor
analysis, make or buy decision etc.
Advantages / benefits / importance of CVP or breakeven analysis:
1. CVP analysis helps to know how much money is left for paying fixed costs (i.e. contribution).
2. CVP analysis helps to know how much profit may be earned from a certain sales volume at a
certain selling price.
3. CVP analysis helps to know the expected selling price and the expected sales quantity for
making a certain profit figure.
4. CVP analysis helps to know the impact of changes in selling price and in sales quantity on profit.
5. CVP analysis is used for fixing sales incentive, sales target, production priority etc.
6. CVP analysis helps to know the required production volume for recovering all costs and thus
for avoiding any loss (i.e. breakeven point).
7. CVP analysis can demonstrate its results in several forms; such as: monetary amount basis, per
unit basis, graphical basis and percentage basis.
8. CVP analysis shows how much of the sales volume is left for profit, after recovering all expenses
(i.e. margin of safety). This enables the company to decide price cuts, sales promotion etc.
9. CVP analysis is used to assess if costs are too high for the business to be successful.
10. CVP analysis is used to decide if certain product is worth launching in the market or not.
Criticisms / assumptions / limitations / disadvantages / weaknesses of CVP or breakeven analysis:
1. CVP analysis requires to classify all costs between fixed cost and variable cost. But all mixed
costs may not be accurately classifiable in this manner.
2. Selling price per unit is assumed here to remain the same at any level of output. But selling
price may decrease in case of a large sales volume (i.e. trade discount).
Page 2 of 43
,3. Variable cost per unit is assumed here to remain the same at any level of output. But variable
cost per unit (such as: labor hour rate or materials price) may increase in case of excessive
production volume, due to shortage of inputs.
4. Fixed cost is assumed here to remain the same at any level of output. But in practice fixed cost
increases beyond the relevant range.
5. CVP analysis ignores variation in machine productivity and labor efficiency.
6. CVP analysis ignores any uncertainty in estimating selling price, sales volume, variable cost
and fixed cost etc.
7. CVP analysis is applicable only to a single product or a single product mix.
8. CVP analysis often assumes that all the produced quantity can be sold in the market.
9. As any other management accounting tool, CVP analysis ignores sunk costs.
10. CVP analysis is absolutely a quantitative technique and ignores any qualitative consideration.
֍֍֍ ֍֍֍ ֍֍֍
The very basics of CVP or breakeven analysis is Contribution. This is a common word in our daily
life, although the sense it makes in Management Accounting is a bit different.
Contribution refers to the excess of sales revenue over the variable cost of production, thus the
amount remaining for net profit after recovering fixed cost.
Contribution in $ = Total sales – Total variable cost = Fixed cost + Profit
= (Selling price per unit – Variable cost per unit) × Number of units sold
= Contribution per unit × Number of units sold
If in your exam you are asked to write the definition, you must put the formula also, without saying.
To understand easier: Sales = Total cost + Profit = Fixed cost + Variable cost + Profit
Contribution in $ = Sales – Variable cost = Fixed cost + Profit
Here we clearly mention “in $” because contribution is also expressed per unit and in percentage.
Page 3 of 43
, Contribution in $
Contribution per unit = Selling price per unit – Variable cost per unit =
Number of units sold
Contribution per unit Contribution in $
Contribution ratio = × 100 = × 100 = 100% – Variable cost ratio
Selling price per unit Total sales
Variable cost per unit Total variable cost
Variable cost ratio = × 100 = × 100 = 100% – Contribution ratio
Selling price per unit Total sales
Variable cost ratio + Variable profit ratio = 100%
All the formulas are the different forms of the same thing and are corollary to each other, so perhaps
not difficult to remember.
As you understand, 100 is multiplied at the end for expressing in percentage.
Contribution ratio is also known as profit-volume (P/V) ratio, variable profit ratio, marginal income
ratio etc. On the other hand, contribution in $ is also known as contribution margin.
Illustration # 1: Sales is 10,000 units @ $10. Variable cost is $3 per unit. Find out: (i) Contribution
margin; (ii) Contribution per unit; (iii) Variable profit ratio; and (iv) Variable cost ratio.
Solution: Contribution margin = Total sales – Total variable cost = (10,000 units sold × $10 selling
price per unit) – (10,000 units sold × $3 variable cost per unit) = $70,000
Alternatively: Contribution margin = (Selling price per unit – Variable cost per unit) × Number of
units sold = ($10 – $3) × 10,000 units = $70,000
Contribution per unit = Selling price per unit – Variable cost per unit = $10 – $3 = $7
Contribution in $ $70,000
Alternatively: Contribution per unit = = = $7
Number of units sold 10,000 units
Contribution per unit
Variable profit or Contribution ratio = × 100 = $7 ÷ $10 × 100 = 70%
Selling price per unit
Contribution in $
Alternatively: Variable profit ratio = × 100
Total sales
$70,000
= × 100 = 70%
10,000 units sold × $10 selling price per unit
Page 4 of 43
