COST – VOLUME – PROFIT ANALYSIS:Target Contribution Margin

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Cost & Management Accounting (MGT-402)

LESSON# 30

COST VOLUME PROFIT ANALYSIS

(Break-even Approach)

Break-even

Cost-volume-profit analysis can be used to calculate break-even.

Break-even is the point where sales revenue equals total cost, i.e. (here is neither a profit nor a loss.

Profit (or loss) is the difference between contribution margin and fixed costs.

Thus the break-even point occurs where contribution margin equals fixed costs

Target Contribution Margin

Target contribution margin is the amount which if equal to fixed cost will give nil net profit,

whereas, if we need to earn a target profit, such profit will be added up into the fixed cost to have

target contribution margin.

Contribution margin per unit can be assumed to be constant for all levels of output in the relevant

range. Similarly, fixed costs can be assumed to be a constant amount in total.

The relationships may be depicted thus:

Contribution Margin per unit

Selling price per unit less variable costs per unit

Total contribution

Volume x (Selling price per unit less variable costs per unit)

Target Contribution Margin

Fixed costs + Profit target

Target Sales in number of units

Target Contribution Margin

Unit contribution

Contribution may be calculated in total, or on a per-unit basis using selling prices and variable costs

per unit.

The difference between contribution and fixed costs is profit (or loss); thus when contribution

equals fixed costs, break-even occurs. In this way a target profit may be converted into a target

contribution margin which may be used to calculate the number of units required to achieve the

desired target profit.

Contribution margin to sales ratio

Contribution to sales ratio (C/S ratio) =

Contribution Margin in Rs

Sales in Rs

Note: you may encounter the term profit to volume (or P/V) ratio, which is synonymous with the

contribution to sales ratio. Profit to volume is an inaccurate description, however, and should not

be used. The C/S ratio is conveniently written as a percentage.

Break even point refers to the volume (sales) at which the entity earns no profit and suffers no

loss.

It is the point where

Contribution margin = Fixed cost

And

Target profit = 0

Contribution margin Fixed cost = 0 Profit

Contribution margin = Fixed cost + 0 Profit

At break even point the target contribution is equal to the fixed cost

Contribution Margin Fixed cost = Profit

185

Cost & Management Accounting (MGT-402)

Contribution margin = Fixed cost + Profit

Practice Question

Q. 1

Income Statement

Rs.

Sales

700 units x Rs 8

5,600

Variable cost 700 units x Rs 6

4,200

Contribution margin

1,400

Fixed cost

1,000

Profit

400

Variable cost over sales

4,200 x 100 = 75%

5,600

Contribution margin over sales

1,400 x 100 = 25%

5,600

Per Unit Calculation

Sales price

Rs 8

Less Variable cost

(6)

Contribution Margin

6 / 8 x 100 = 75%

2 / 8 x 100 = 25%

Total

per unit

Sales

700 units x Rs 8

5,600

100%

Variable cost 700 units x Rs 6

4,200

75%

Contribution margin

1,400

25%

Fixed cost

1,000

Profit

400

Break even sales in Rupees

Remember the formula to calculate required amount in absence of certain information:

Given Amount x

% of required amount =

Required Amount

% of given amount

Here, to calculate break even sale, we need contribution margin to be equal to the fixed cost so

that the profit is zero.

Now if the target contribution margin is equal to Rs. 1,000 then what would be the sales at this

point?

Now the above formula will be applied to calculate breakeven sales:

Target CM is the given amount and its % is 25, so the sale which is 100% will be:

Rs 1,000 x

100 = Rs 4,000

186

Cost & Management Accounting (MGT-402)

Rs 1,000 x 1 =

Rs. 4,000

Rs 1,000 =

Rs. 4,000

So,

Break even Sales in Rs. =

Fixed cost

C/S ratio

Check

Income Statement

Rs.

Sales

500 units x Rs 8

4,000

Variable cost 500 units x Rs 6

3,000

Contribution margin

1,000

Fixed cost

1,000

Profit

Break even sales in units

Simple formula:

Break even sales in Rupees = number of units

Sales price per unit

4,000 = 500 units

Direct formula

Target CM

CM per unit

Here the target contribution margin is equal to the fixed

Fixed Cost

CM per unit

Rs. 1,000

= 500 units

Break even sales in Rupees =

Target CM

Contribution to sales ratio

Break even sales in units=

Target CM

Contribution margin per unit

Q. 2

Calculate Sales to target profit of Rs. 500, using the information given in practice question no. 1.

Sales

***

Variable cost

(***)

Contribution margin

***

Fixed cost

1,000

Profit

500.

187

Cost & Management Accounting (MGT-402)

Target contribution margin = Fixed cost + Target profit

1,000 +

500

1,500

Sales to earn target profit of Rs. 500

= Rs 1,500 x 100 = Rs. 6,000

Rs 1,500 = Rs. 6,000

0.25

Check

Income Statement

Rs.

Sales

6,000

Less Variable cost

4,500

Contribution Margin

1,500

Less Fixed cost

1,000

Profit

500

Fixed cost + Target profit

Contribution to sales ratio

Problem Question

A company sold fans at Rs 2,000 each. Variable cost Rs. 1,200 each and fixed cost Rs. 610,000.

Calculate:

a. Calculate break even sales in Rupees.

b. Break even sales in units.

c. Sales in units to earn a profit of Rs. 20,000.

Multiple Choice Questions

The following details relate to a shop which currently sells 25,000 pairs of shoes annually.

Selling price per pair of shoes

Rs.40

Purchase cost per pair of shoes

Rs.25

Total annual fixed costs

Rs.

Salaries

100,000

Advertising

40,000

Other fixed expenses

100,000

Q. 1

What is the contribution per pair of shoes?

A Rs.15

B Rs.30

C Rs.7.50

D Rs.18

Q. 2

What is the break-even number of pairs of shoes?

A 14,000

B 16,000

C 28,000

D 32,000

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