Approaches To Cost-Volume-Profit(CVP) Analysis

1. Contribution Margin Statement Approach

Break even point(BEP) and other required cost volume profit relationships can be explained through contribution margin by following the variable costing income statement approach under which all fixed costs of the period are deducted out of the contribution margin of the same period. Only the variable costs vary proportionally to the level of outputs or sales.

2. Equation Or Formula Approach

The most often practiced approach of cost volume profit analysis is the equation or formula approach. In fact, we use equation approach to the solution of CVP analysis instead of the graph or the income statement.

As we know,

Sales= Variable expenses + Fixed expenses + Net profit

If sales volume= Q units, variable cost pe

r unit = V, total fixed cost= FC and selling price per unit = S, then the equation can be simplified as;

QS = QV+FC+Profit

or, QS-QV= FC+Profit

or, Q(S-V)= FC+ Profit

Simplifying the equation, we get:

Q = FC+Profit/S-V

Sales unit = FC+Profit/CMPU

Where,

S-V= CMPU

Above equation or formula can be applied to find out any one unknown value of the variable either fixed costs or variable costs.

In order to compute the sales revenue instead of the sales units the following formula is used:

Sales Revenue = Sales Units x Selling price per unit (SPPU)

Concept And Meaning Of Contribution Margin Ratio

Contribution margin expressed as a percentage on sales revenue is known as contribution ratio. The percentage of contribution to the total sales is referred as the C/M ratio. It is also the remaining percentage of the variable cost ratio.

CMPU = SPPU - VCPU
C/M Ratio = (Sales Revenue - Variable Costs)/Sales Revenue
Or,
C/M Ratio = (SPPU- VCPU)/SPPU
Or,
C/M Ratio = 1- Variable Cost Ratio
Or,
C/M Ratio = (Fixed Costs + Net profit(loss)/Sales Revenue
Where,
CMPU = Contribution margin per unit
SPPU = Selling price per unit
VCPU= Variable costs per unit
C/M Ratio = Contribution margin ratio.

Contribution margin per unit (CMPU) of $ 20 means each unit of sales contributes $ 20 towards the recovery of fixed cost first and then realization of profits.
A 45% C/M ratio means each dollar of sales revenue contributes $ 0.45 towards the recovery of fixed costs first and then realization of profits.
Contribution margin ratio sometimes referred to as Profit Volume Ratio(P/V Ratio). But one should be cleared with the P/V ratio that it is not the ratio of net profit to sales revenue. P/V ratio is the percentage of marginal profits(or change in profits) to marginal sales revenue.
Since fixed costs do not change within the relevant range in the short tun, net profits change by the same amount as the contribution margin change.
Therefore,
C/M Ratio = P/V Ratio = Change in contribution margin/change in sales revenue
= Change in net profits/change in sales revenue