 Dear students, in the last session we were discussing fundamentals of CVP, we have done a revision and we have also started some cases. First let us continue with that. So, for those who have missed the last session, we will do a very brief revision of concepts. So, what do you understand by contribution per unit? What is the formula? It is sales minus variable cost. What is PV ratio? Contribution upon sales, that leads us to BP. So, what is the formula for BP? Fixed cost upon contribution per unit or fixed cost upon PV ratio. Using these fundamental concepts, we have seen how we can take variety of decisions like product mix decisions, like whether to outsource or not type of decisions or to decide on the level of activity and so on. In the last session, we were doing a case on calculation of cost in difference point and also calculation of leverages. Please read the case once again carefully. So, you can see here, mithai is a product which can be manufactured by automated system or by hand. Then the data is given about sales, variable cost, fixed cost. This fixed cost includes interest expenses that is also given. We have to compute PV ratio BP cost in difference point, then profit at the current level and at the cost in difference point level, then PV ratio and BP operating leverage, financial leverage and total leverage at both the levels by both the methods. So, how to proceed? Those who have seen the earlier video would have known up to a certain point which we have done. So, first is very simple. We will try to calculate PV ratio and BP that I think all of you are very much familiar. So, PV ratio is contribution upon sales. We have first calculated contribution. We got a PV ratio of 0.73 for automated system and 0.4 for handmade system. BP is FC upon PV ratio. We know the fixed cost. Do not consider this interest right now. We will need it, but we will need it when we go for calculation of leverages. Right now, we take the total fixed cost of 9 lakhs and divide it by PV ratio of 0.73. So, BP becomes 12,27,000 and by handmade system it is 7,50,000. Why is BP lower in a handmade system? Because handmade system has lower fixed cost. It is just relax. So, BP is also low. In other words, handmade system is preferable when demand is low and automated system is preferable when the demand is high. Now, the question is up to what level of sales is handmade system preferable? So, what will be your answer? Is it preferable up to 7,50,000 or up to 12 lakhs? Because below 7,50 by both the methods we are in losses. At 7,50 handmade starts making some profit. At 12,27,000 automated system starts making some profit, but still the profit from handmade will be higher. So, we will have to calculate that point of sales where the profit by both the methods is same and that is known as cost indifference point. So, at that point we are in difference to both the technologies whether handmade or automated it makes no difference, but if sale exceeds that level it is better to go for automated system. So, let us try to calculate the cost indifference point. Now, the formula is very similar to that of BEP. In BEP, we did FC upon PV ratio. Now, we will do difference in FC upon difference in PV ratio. So, you can see here we have tried to calculate the difference. So, fixed cost there is a difference of 6 lakhs. In PV ratio there is a difference of 0.333. So, cost indifference point is FC upon PV ratio. So, we get 18 lakhs. Up to this we are done in the last session. Now, let us go to the next part. Now, we are asked to calculate the profit at the current level and at cost indifference point level. So, now if the sales are 18 lakhs what will be the profitability that is something we would try to calculate. If you are able to do it, please take pen and paper and try to do it on your own because it is very simple. So, now you know how the profits are calculated in CVP. Usually, we start with contribution and subtract fixed cost. So, same thing we will do. So, we have already calculated contribution. So, sale less variable cost we get contribution. We do not need interest etcetera right now. So, profits are contribution minus fixed cost. So, profit is 2 lakhs from automated and 1 lakh from handmade. So, first part of the question was compute the profit at the current level and at such level by both the methods. So, computation of profit at current level is something we have done right now. Now, let us use the same structure and try to compute the profit at cost indifference point correct. How much is a cost indifference point? We have just calculated it to be 18 lakhs. So, let us put 18 lakhs here and at that point naturally both the sales are going to be constant. How much will be the variable cost? We know that variable cost is sales into PV ratio. So, variable cost will be 13 lakh 20 and 7 lakh 20 PV ratio I am sorry contribution is sales into PV ratio. So, this is not variable cost what we have done right now is a contribution. Variable cost actually we need not worry about. So, are you able to get it? So, our contribution will be 13 lakh 20 from automated system and 720 from handmade system minus fixed cost profit is 420 and it is same it has to be by definition cost indifference point was such point where the profits are same and the revenue is also same is it clear to. Now, let us go to the next part. So, we have computed the profit at current level and at cost indifference point. Now, compute the PV ratio and BEP at such levels by both the methods. So, how much will be the PV ratio and BEP for each of them? Current level we have already calculated how much it will be for cost in at a cost indifference point is it going to change? Of course, it would not change it is just asked to test are you able to do it? So, at cost indifference point or at whatever point the PV ratio does not change PV ratio will remain at 0.73 and 0.44 same way BEP also will not change it is fixed cost divided by PV ratio. So, it is 1227 and 750 as was before. So, this question is not required, but just to test your knowledge. So, at such level that is at cost indifference point this is the PV ratio and BEP. Now, compute operating leverage financial leverage and total leverage. So, what is the formula for operating leverage? Are you able to remember? So, in operating leverage we try to know the relationship between the contribution and profit before interest and taxes. So, to do it first let us write the formula contribution upon PBIT. So, to do it we need to know the PBIT now. So far we have ignored completely ignored the interest, but now we will use the interest information and try to calculate it. So, let us push this formula down. Now, let us start with the current level we know the profit as of now. So, I am just taking it again. So, profit at the current level this was a structure, but we are given that fixed cost includes interest of 150,000 respectively. So, now this fixed cost we would like to break into operating items and interest. So, here I am just qualifying that now I will consider fixed cost other than interest. So, interest of 1 lakh and 150 which was included now needs to be excluded. So, fixed cost which was 9 earlier now becomes 8 lakhs and for handmade system it becomes 250 and the profit which was calculated is actually PBIT. Now, from this PBIT we would like to compute PBT. So, we had already calculated earlier the PBT that will remain same, but we have added one more level and tried to calculate PBIT. Now, calculate operating leverage using this data. So, our formula for operating leverage is contribution upon PBIT. So, we know contribution is 11 lakhs divided by PBIT. So, we get 3.66 in automated in handmade system it is 2.66. Now, in the same way let us try to calculate financial leverage what is the formula do you remember the formula it is PBIT upon PBT. So, in operating leverage we were linking contribution minus PBIT the difference being fixed cost. Now it is PBIT minus PBT the difference between two these two figures is interest. So, it is now 3 lakhs upon 2 lakhs. We have been asked to calculate I will go back to the problem operating leverage financial leverage and total leverage at both the level of activities. So, we would also try to calculate the total leverage do you remember the formula for total leverage it is a combination of the two leverages. So, now, it is contribution upon PBT. So, it is 11 lakhs divided by 2 lakhs. You can also cross check it because it is nothing but a product of the two leverages. So, it is 3.66 into 1.5. So, either you can multiply the two leverages and get it or you can get it by a formula either way it is possible I will just show you by the other method also. So, we have got all the three leverages at the current level. Let us repeat the same process if we do it at the break even point level. Now, I think it is very simple I am just copying it, but you try to do it by a pen and paper. So, now, instead of the current level of sales 15 lakhs and 10 lakhs what level of sales we will put? We would try to go for cost in difference point level which is 18 lakhs. Now, variable cost will change it will not remain same. So, how much will be the variable cost at this level? It has been computed. So, we can take it now. So, I am pasting the values now the variable cost is 1320 and 720. So, we get a contribution of 480 and 10 lakhs 80,000 fixed cost remains 8 lakh and 250. So, at 18 lakhs I will just recheck the contribution. We have taken it from this figure. So, which is B 180 into B 160. So, B 160 was the PV ratio. So, we do not have to recalculate the contribution that is something which is causing problem. So, we know it is 1320 and 720 the fixed costs are 8 lakh and 250. So, PBIT is 520 and 470. We deduct interest expenses and we get PBT which is same which we had already seen. What we are trying to learn is what is a leverage? Keep in mind that leverage does not remain same. Unlike PV ratio and BEP the earlier case we were asked to calculate PV ratio and BEP at cost in difference point and it was same because at any level of activity PV ratio and BEP remains constant. But that is not the case with the leverages. So, leverages have to be recalculated. So, now they are recalculated you can see it is contribution upon PBIT operating leverage. So, it was 3.66 now it has come down here it was 2.66 this also has come down. So, we do operating leverage I think here by mistake I have written operating leverage only again this was the financial leverage. So, I will just correct it the formula is correct financial leverage is PBIT upon PBT. So, now financial leverage which was 1.5, 1.5 each has become 1.23 and 1.11 and the total leverage this is nothing but a multiplication of operating into financial we get 2.34 and 1.71. So, please look at the whole case is it clear to you in this case we have tried to learn the cost in difference point and we have also tried to learn what are the leverages. So, I hope now these things are properly revised for you Dear students let us do a few more some on CVP BEP analysis. So, have a look at the problem Prathamesh limited provides the following data for year 2012. It manufactures herbal products at these two sites Manali and Ruchikesh data is available variable expenses are 5000, 8000 semi variable is 6000 each fixed expenses are 3000, 6000 total cost 1420 profits are 3000 and 5000 in year 2013 the production is expected to increase by 20 percent prepare the budget for year 2030. So, how to make it can you think over this is slightly a different problem because the information about 2 sites are given. So, they have 2 production facilities at 2 sites budget for a particular year that is 2012 is available now we have been asked to make a budget for 2013. So, how to proceed it has been given that production is expected to increase by 20 percent that data we should use and with the help of that data we would like to proceed for preparing of the next budget. So, let us look at the variability of the cost you will realize that first 5000 rupees is specifically given as variable cost next 6000 is given as semi variable expenses with 70 percent variable. So, we need to first break that down and calculate how much are the variable cost we also need to calculate how much are the sales. So, I am just showing you how exactly it can be done I request you also to solve along with me. So, that you actually get the feel of doing a problem. So, now first see how we can calculate the sales. So, anyone can give a hint how sales can be calculated think over how sales can be calculated we have been given all the cost we also know the profit. So, the easiest thing for us is to start with calculation of sales. So, sales you know is total cost plus total profit. So, sales are 17000 and 25000 respectively for Manali and Rishikesh sites. Now, with this information let us try to break up the semi variable cost into variable and fixed. Now, how to do that how to break the semi variable it has been mentioned that 70 percent is variable. So, how much is a variable portion it will be 70 percent of 6000. So, 4200 for both the sites the cost is same. So, I have worked out 4200 now the remaining naturally is a fixed portion. So, look at the fixed portion also. So, 1800 I think you can do it orally as well 1800 is a fixed portion of semi variable cost. Now, let us try to present the cost structure properly giving out variable and fixed cost. What we are doing right now are working nodes. So, please give specifically that these are working nodes. Now, let us try to prepare the budget for 2013 as has been asked. I am doing it lightly slowly I hope you are able to pick up with me you are able to do with me because we have done number of sums now. Usually, a budget will start with sales. So, we would try to start with sales we are making it for the two sites Manali and Rishikesh. So, please mention that now, we know the value of sales in the current year that data we would like to use for the preparation of budget for 2013. In 2013 it is given that production is expected to increase by 20 percent there are no stocks. So, all production is assumed to have been sold. So, now, let us try to calculate the sales. So, we know the sales for the year 2013 for 2012 which is 17 and 25000. Let us try to use that information for calculating the sales for 2013. Now, we know that there is a 20 percent rise in the sales. So, it is 17000 into 1.2. So, we get 20400 and in the Rishikesh site it is 30000. That is the value of sales we are looking for less. First, let us deduct which cost you will deduct from sales. I think you have guessed it right we will first deduct variable cost because sales and variable cost both are variable in nature and sales minus variable cost is what? It is nothing but the contribution. Now, you can see in the last year the variable cost was 5000 and 8000. So, that cost will naturally increase by 20 percent. So, 5000 into 1.2. So, we get 6000 and 9600 for Manali and Rishikesh sites. Same way we will also take variable portion of semi variable cost because variable portion of semi variable cost is also a part of variable cost. It is 4200. So, we multiply it by 1.2 it becomes 5040 for both Manali and Rishikesh. Now, this total would be the total VC. So, 1140 and 14640. Now, sales minus variable cost gives us contribution. So, I hope you remember that we have done that contribution is a prime source for earning profit. So, from 20400 minus 11040 you get 9360 and 15360 as a contribution. From contribution we would deduct fixed cost. Now, fixed expenses are given as 3000 and 6000 they are fixed. So, they would not change apart from that there is a fixed portion of SVC that also we will deduct. So, total FC is 4800 and 7800. Now, contribution minus fixed cost 4560 and 7650 is my profit. Now, the question which was asked was from the given data prepare the budget for 2013. So, we have prepared the budget starting from sales to profits. Is it clear to all? Now, let us look at the next case. Now, in the next case please have a look at it and read it carefully. Bamboo chairs can be made by two methods either by using automated system or by handmade system. The data is like this sales for automated is 18 lakhs for manmade it is 10 lakhs. Variable cost is 6 lakhs each at that level. Fixed cost is 9 lakhs, 3 lakhs. Interest expenses included are 10000 and 5000. Calculate PV ratio and BEP also compute cost in difference point and compute the profit at current level and at such level by both the methods. Now, a similar problem we have done earlier. So, I hope you can do it very fast. Let us please try to practice and do it with me. So, we have to calculate first the PV ratio and BEP. So, how to calculate? So, we have been given variable cost which is 86 and 6. So, we can definitely calculate contribution sales minus VC. We get contribution as 12 lakhs and 4 lakhs respectively. Now, from contribution we can calculate PV ratio. The question which is asked is calculate PV ratio and breakeven point. So, first answer we get is PV ratio. I hope you all know the formula it is contribution upon sales. So, we get 0.667 and 0.4. The fixed cost again are given 9 lakhs and 3 lakhs. So, fixed cost is 9 and 3. Now, interest expenses included in fixed cost is 1 lakh and 150, but right now we are not concerned about it. So, we can directly calculate breakeven point. What is the formula for BEP? It is FC upon PV ratio. So, fixed cost is 9 lakhs divided by PV ratio. We get 13,50,000 and 7,50,000 for automated and handmade system. So, our question first part is compute the PV ratio and BEP in both the cases that we have done. Next is calculate cost indifference point. So, what is the formula for cost indifference point? Take a guess. We have just done it in earlier problem. So, cost indifference point is difference in FC upon difference in PV ratio. This is very simple and very similar to breakeven point. In breakeven point formula, we have FC upon PV ratio. Here, we take the difference in those figures. So, we would try to calculate the difference which is 0.226 and difference in FC is you can orally see it is 6 lakhs. So, cost indifference point is 6 lakhs divided by 0.2667. So, we get 22,50,000 as cost indifference point. Next, they are asked compute profit at the current level and at such level by both the methods. So, current level profitability first we will try to calculate. We already have all the data. So, we can immediately know the profit. So, you know that the variable cost is 12 lakhs. Variable cost minus fixed cost, we will immediately get the profit. So, 12 minus 9, we have 3 lakhs and 1 lakh as a profitability at a current level. Now, let us see how much is a profit at cost indifference point. So, this is the computation of profit at current level. So, at cost indifference point, we need to take sales of 22,50,000 and then we will try to calculate the profit at that level. Now, you will observe that we need to revise our variable cost because variable cost will change with the level of activity. Currently, it is 6 lakhs each. So, 6 lakhs into 22,50 divided by 18 lakhs that is 1800. This will be the new variable cost. So, it comes to 750,000. For both, it will be same. So, you can see here that for 18 lakhs of sale of automated the variable cost was 6. So, here we have revised it correctly, but when it comes to handmade, we have to take it as 22,50 lakhs. So, variable cost is 13,50,000, contribution is 15,9 and so profits are 6 lakhs each. So, this is what we were trying to look at. So, now this is the profit at cost indifference point. I have changed it at a current itself. So, I will just make a small revision. So, the profit over variable cost over here at cost indifference point has to be 22,50 upon 10 lakhs. So, it becomes 13,50,000. The contribution is sales minus VC. So, it comes to 10,50 and the sales are 18 lakhs now. So, are you able to get it? So, here originally our profit was our sales was 18 lakhs and 10 lakhs and variable cost was 6,6 each. So, the contribution was 12 lakhs and 4 lakhs and our fixed cost was 9 and 3 respectively. So, profit was 3 lakhs and 1 lakhs. Now at cost indifference point, we are at a sale level of 22,50,000 and that gives me a variable cost of 750 and 13,50 minus fixed cost of 9 and 6. We get exactly the profit of 6 lakhs. You are able to get it through. So, the question was compute the profit at the current level and at cost indifference point. Next is compute PV ratio and BEP. I think you know that PV ratio and BEP do not change with the level of activity. So, they will remain constant. They need not be calculated again, but we will just show it for more clarity. So, PV ratio which is 0.66 will remain unchanged and BEP also will remain unchanged. Now, next question is compute operating leverage, financial leverage and total leverage. Again, we have done it. So, I hope you remember it. In case of operating and financial leverage, we will need to break down our fixed cost into interest portion and common portion. So, first let us do that and then we can easily calculate the operating and financial leverage. So, now we know that the fixed cost includes interest of 1 lakh and 50,000 each. So, now instead of taking 9 and 3, we will reduce the fixed cost as we have taken here 9 lakhs. We will take it 8 lakhs and instead of 350, we will take 300, we will take 350. So, we get profit before tax, profit before interest and tax popularly known as PBIT. I will just expand the size. Now, from this we need to deduct interest cost. Now, the interest cost is given to us which is 1 lakh and 50,000. So, this gives us PBT or profit before tax. So, 3 lakh and 1 lakh. So, the profitability at the level has remained same. We have just shown it in a different format. Now, we have to calculate operating, financial and total leverage. Now, what is the formula for operating leverage? Do you remember? Yes, anyone would like to make a try operating leverage? I hope you are all getting it. It is PBIT upon PBT that is financial leverage. Operating leverage is contribution upon PBIT, but I am just writing it for your benefit. So, we get 3 and 2.66. Now, financial leverage, this is PBIT upon PBT. So, 1.33 and 1.5 and total or the combined leverage. So, the formula is similar to the earlier one. It is contribution upon PBT now. So, it is 4 and 4 for both. Now, this is the leverage at the current level. Now, they have asked compute operating, financial and total leverage at both the levels by both the methods. So, right now, we have calculated leverages at the current level. Now, let us do the leverage calculation at cost indifference point. All of you please try to do it with me. Now, cost indifference point you are aware. The total sales are 22 lakhs. So, total sales are 2250. Contribution is 750 and 1350 and we have PBIT of 7 lakhs and 650 each. PBT is 8 lakhs and 6 lakhs. These figures you can immediately see, since the formulas are already there. So, now the combined leverage is 2.5 and 1.5. So, I hope now the concept of leverages is clear to you more in detail. So, in today's session, we have done a few extra sums on CVP and BEP analysis. I hope the fundamentals are reinforced now in your mind. I will do a quick revision for the benefit of everyone. The first concept which you should be aware is of the variable cost and fixed cost. So, variable cost are those costs we change with the level of activity in the direct proportion. Fixed cost do not change with the level of activity at all. All semi variable cost we break down into VC and SVC. Then sales minus variable cost we get contribution. From contribution, we can calculate PV ratio which is contribution upon sales or it can also be contribution per unit upon selling price per unit. Then we get break even point. Break even point has 2 definitions or 2 equations. In terms of quantity, it is fixed cost divided by contribution per unit or break even point in value is fixed cost upon PV ratio. From that, we have gone to a point known as cost in difference point. This is a point at which the profits are same at a particular level of activity and that level of activity is called as cost in difference point. So, the formula is difference between fixed cost upon difference between PV ratio. We have also seen a concept known as margin of safety. So, margin of safety is nothing but current sales minus break even sales. We can also have it as a percentage. So, margin of safety in percentage is current sales minus break even sales divided by current sales. Now, margin of safety tells you that how much your sales can fall before which you can go in losses. So, if MOS is 25 percent that means a loss of up to 25 percent of sale is tolerable, you will still not go into loss. So, that much of decline in sales the company can do with without going into losses. Now, all these fundamentals are very much useful to decision making. So, we have also done a few problems on decision making. For example, we have looked at product mix decisions. So, we do calculate the contribution per unit and based on the contribution per unit if you do ranking that tells us which product is better, which product is to be concentrated. Suppose, there is a restriction on total sales in terms of value instead of contribution per unit we go by a PV ratio. Suppose, some factor or some resource for production is in short supply for example, say let us say raw material. If raw material is in short supply we calculate contribution per kg of raw material or unit of raw material and that contribution is used for ranking the products. So, CVP analysis is helpful in product mix. It is also helpful in profit planning. We have done a case on calculating the budget. So, based on last year's budget we can make the current budget. We can also decide at what level of activity we need to operate to earn a certain level of sales. It is also useful to make flexible budgets. So, we may operate at 1000 units or 1100 units or 1200 units or 1300 units. So, we can make budgets for the respective levels. That also will be facilitated by CVP analysis. Like this CVP analysis has variety of uses and it is very much useful to the management at various levels. Thank you so much.