Marginal Costing & Break Even Analysis

Marginal cost The amount at any given volume of output by which the aggregate costs are changed if the volume of output is increased or decreased by one unit The amount at any given volume of output by which the aggregate costs are changed if the volume of output is increased or decreased by one unit Assumptions: Assumptions:  variable cost varies in direct proportion with the level of activity  Per unit selling price remain constant  No variation due to stock

CVP relationship Aims at studying the relationship existing among the factors and its impact on amount of profit Aims at studying the relationship existing among the factors and its impact on amount of profit Relationship between: Relationship between: Selling price per unit and total sales amount Selling price per unit and total sales amount Total cost Total cost Volume of sales Volume of sales

Basic equation Profit = Sales – Total cost Profit = Sales – Total cost Profit = Sales – (Variable cost + Fixed cost) Profit = Sales – (Variable cost + Fixed cost) Profit = Sales – Variable cost – Fixed cost Profit = Sales – Variable cost – Fixed cost Profit + Fixed cost = Sales – Variable cost Profit + Fixed cost = Sales – Variable cost Sales – Variable cost = Contribution = Fixed cost + profit Sales – Variable cost = Contribution = Fixed cost + profit Contribution – Fixed cost = Profit Contribution – Fixed cost = Profit

Profit Volume Ratio (P/V) Indicates the contribution earned with respect to one rupee of sales Indicates the contribution earned with respect to one rupee of sales PV ratio = contribution / sales * 100 PV ratio = contribution / sales * 100 PV ratio = change in profit / change in sales * 100 PV ratio = change in profit / change in sales * 100 Means Means Sales * PV ratio = Contribution Sales * PV ratio = Contribution Contribution / PV ratio = Sales Contribution / PV ratio = Sales Properties of PV ratio: Properties of PV ratio:  It remains constant at all the levels of activities provided per unit sales price & variable cost remains constant  PV ratio remains unaffected by any variation in fixed cost though overall profit may change  High PV ratio indicates high profitability – point to increase sales promotion efforts to increase sales volume  Low PV ratio indicates low profitability – efforts can be made to increase the profits by increasing selling price or by reducing variable cost.  Overall profitability can be increased by concentrating more on product having high PV ratio

Break Even Point No profit no loss No profit no loss Contribution = Fixed cost Contribution = Fixed cost BEP( in units) = Fixed cost / contribution per unit BEP( in units) = Fixed cost / contribution per unit BEP( in amount) = Fixed cost / PV ratio BEP( in amount) = Fixed cost / PV ratio Contribution beyond BEP is profit Contribution beyond BEP is profit

Margin of Safety Indicates soundness of business Indicates soundness of business High margin of safety – BEP is much below the actual sales High margin of safety – BEP is much below the actual sales Margin of safety = Sales – BEP sales Margin of safety = Sales – BEP sales Margin of safety = Sales – fixed cost/ PV ratio Margin of safety = Sales – fixed cost/ PV ratio Margin of safety = Sales * PV ratio – Fixed cost / PV ratio Margin of safety = Sales * PV ratio – Fixed cost / PV ratio Margin of safety = Contribution – Fixed cost/ PV ratio Margin of safety = Contribution – Fixed cost/ PV ratio Margin of safety = Profit / PV ratio Margin of safety = Profit / PV ratio

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