In previous written lecture, I have explained that Cost Volume Profit Analysis is useful to knowing the answers of lots questions of businessman like to know the numbers of units sold at given fixed cost and selling price and variable cost, to know value of sale on our estimated profit, to know whether increasing variable cost is sale promoting or demoting.
1st Step : To Calculate Break-Even Point
Break-even point is the position where total cost will equal to total revenue. When we will calculate this point, we will become positive to calculate the point where our total revenue will more than total cost.For Cost Volume Profit Analysis, it is very necessary to calculate break-even point. Because different business's nature and level is different, so, total cost and total revenue will be different from another business. For calculating total cost, we will calculate both fixed cost and variable cost of business.
A -Part : To Calculate the Fixed Cost
For calculating total cost, we need to calculate fixed cost. Take pen and copy and start to make the list of your business's fixed cost by showing figures near each fixed cost. We are showing small sample in following list. You can also make you own. You must remember, all expenses are the part of fixed cost which do not change when production will change.
c) office salary
B- Part : To Calculate the Variable Cost
Variable cost will be added in fixed cost for calculating total cost. So, it is very compulsory to calculate the variable cost of your business. Variable cost will increase or decrease when your production will decrease or increase. following are the examples
a) labor cost
b) Electricity and lighting cost
c) machine repair
Now, you can Calculate break-even point manually by comparing total cost and total revenue which you have come from sale. Change your unit production for reaching total revenue upto total cost. After changing the number of units, your variable cost will change and you will see soon, you will reach your total cost which will equal to total revenue.
2nd Step : Contribution Margin
Contribution margin is a sale price which we calculate after deducting our all variable cost. We can calculate contribution margin with following formula.
= Sale price per unit - Variable Cost per unit
Sale price per unit is $ 175 and variable cost is $ 100 = Contribution margin per unit will be = $ 75
Contribution margin % = Contribution margin per unit / sale price per unit X 100 = 42.8%
If sale price per unit is $ 125 and variable cost is $ 50 - Contribution margin per unit will be = $ 75
Contribution margin % = Contribution margin per unit / sale price per unit X 100 = 60%
For cost volume profit analysis, it is very inevitable to know contribution margin because contribution margin will use all the formulae which will be helpful for manager to solve business problem.
We can calculate following things with Contribution margin under cost volume profit analysis.
1. Value of Sale at Break Even Point
= Fixed Cost / Contribution margin %
If fixed cost is $ 400 million and contribution margin is 60%, then we must sold if we want to keep our safe side where our total cost will equal to our total revenue (break even point)
= $ 400 million / 60% = $ 666.66 million
2. Value of Sale at Your Estimated Profit
If you want to go upward, you have to estimate profit which you have to achieve. For this, Cost Volume Profit analysis provide very useful formula which which can know just small change in the formula of value of sale at break even point
= (Your Estimated Profit + Fixed Cost ) / Contribution margin %
If fixed cost is $ 400,0,00,000 and contribution margin is 60% and you want to achieve $ 14000 profit also, then we must sold above break even point.
= $14000 + $ 400,0,00,000 / 60% = $ 666,6,90,000
Contribution margin will also be helpful for taking the decision whether sale price should decrease or increase because when you will change the sale price, contribution margin will also change and above two calculations will also be affected.