1. Cost-Volume-Profit Analysis Rajendra Desai, XIME, 2009

2. Definitions Cost-volume-profit (CVP) analysis is a technique that can be used to examine the effects on profit of changing sales volumes, sales prices or costs, regardless of whether those costs are related to units, batches or facilities (variable or fixed ). Contribution margin is equal to the difference between Revenue per unit and the flexible costs per unit. The contribution margin can be thought of as first contributing towards recovering the capacity- related costs. Contribution margin ratio is equal to contribution margin divided by the revenue. Operating Leverage = contribution margin / operating profit. Break even point = profit is zero, and also of course, the loss is zero. In the accounting model, this is defined as the level of operation where the total sales revenues exactly equal the total costs. Rajendra Desai, XIME, 2009

3. Break Even Point Breakeven point in units = Fixed costs / Contribution margin per unit Breakeven point in Rupees = Fixed costs / contribution margin % Rajendra Desai, XIME, 2009

4. Operating leverage Operating Leverage reflects the extent to which change in sales affects the profits = % change in operating income / % change in sales = contribution / operating profit = (sales – variable cost) / (sales – variable cost – fixed cost) = (qty. at which operating ratio calculated x (price per unit – variable cost per unit)) / (qty. at which operating ratio calculated x (price per unit – variable cost per unit) – fixed costs) Rajendra Desai, XIME, 2009

5. CVP Analysis Example SalesSales DropSales Incr. Sales100250000002000000032500000 Variable Costs75187500001500000024375000 Contribution25625000050000008125000 Fixed Costs246000000 Operating Profit1250000-10000002125000 Operating Leverage25.00 Change in Sales -20%30% % Change in Operating Profit - 500%750% Rajendra Desai, XIME, 2009

6. Impact of Change in Fixed Costs by -20.00% SalesSales DropSales Incr. Sales100250000002000000032500000 Variable Costs75187500001500000024375000 Contribution25625000050000008125000 Fixed Costs19.204800000 Operating Profit5.8014500002000003325000 Operating Leverage4.31 Change in Sales -20%30% % Change in Operating Profit - 86%129% Rajendra Desai, XIME, 2009

7. Impact of Change in margins by 5.00 % SalesSales DropSales Incr. Sales100250000002000000032500000 Variable Costs70175000001400000022750000 Contribution30750000060000009750000 Fixed Costs246000000 Operating Profit6150000003750000 Operating Leverage5 Change in Sales - 20%30% % Change in operating Profits - 100%150% Rajendra Desai, XIME, 2009

8. Conclusions Firms with high operating leverage have a high sensitivity of their operating profits to sales volumes. Low leverage means lower fixed costs or higher variable costs resulting in low sensitivity of operating profits to changes in sales. High fixed costs mean high break even which in turns increases risk and operating leverage. If sales increase operating profits increase rapidly, with sales decrease operating profits drop rapidly increasing risk. Rajendra Desai, XIME, 2009