 Dear students, we have already done our module 12 on cost volume profit analysis. Let us do some more cases and problems, so that there is more conceptual clarity and you will know how those concepts can be applied to real situations. So, try to remember what we had done under cost volume profit analysis. Are you able to remember what was covered there? Have a look at the slide. At that time, we had discussed these issues about fixed cost, variable cost, semi variable cost. Then we had gone into discussion on contribution, break even point, PV ratio and we had also seen how these concepts can be used in various decision making situations. So, I would not repeat everything, but just try to remember what is meant by fixed cost. Anyone is able to remember what is a fixed cost? So, the cost which does not change with the production or with the level of activity is what is called as fixed cost, whereas the cost which changes in the direct proportion to level of activity is a variable cost. Semi variable is something in between, it does change, but not in the same proportion. So, we break down the semi variable cost into fixed portion and variable portion. Now, what is meant by contribution margin? Now, variable cost as you know by definition changes with the level of activity. So, we compare that with the volume or the sales. So, sales minus variable cost gives us contribution. That is a profitability at a gross level. From that contribution, we need to pay fixed cost to get the profit. Let us see the formulas as well of what we had already seen. This is a graph of fixed cost. So, you can see that though the sales rise, fixed cost essentially remains constant. It is a horizontal line. As against this, the variable cost is starting at 0 and will continuously go up, will continuously increase. Semi variable cost is like steps. It follows the step pattern. With this, we will try to go to break even point. I will not repeat assumptions, etc. I hope you remember these things. So, now instead of looking at profit as sales minus total cost, we break down the total cost into variable and fixed. So, we first calculate contribution, which is revenue minus variable cost and from that contribution, we reduce fixed cost to get the profit. Now, what do you mean by PV ratio? Profit volume ratio. What is the formula? It is basically a comparison of contribution to sales. So, the formula of PV ratio is contribution divided by sales. Now, let us go to BEP or break even point analysis. So, what is meant by BEP? It is that level of activity at which profits are 0. So, if number of units are below that level, we will be in losses. At that level, it is equal to 0 and above that level, we are in profit. Such level or such figure is called as BEP. Then you can look at BEP graphically. You will see the red line starting from 0 is a sales line. This goes up. Here is a line, which is total cost line, which starts at a particular level in this case at 1 lakh, because fixed cost will be incurred at 0 production also. And then it goes up. The sales line crosses it and goes beyond that line at a particular point. That point is nothing but BEP. This is the point where total cost and total expenses match. Below that point, you can see there is a loss area, because loss will be incurred if output is less than the break even point level. Moment we achieve a level of activity beyond the break even point level, we go into what is known as profit area. You can see here, this is a profit area, below is a loss area. So, I hope you remember these concepts. We did a very, very brief revision kind of. You can see the formula of BEP. There are two formulas for calculating in units. It is fixed cost upon contribution per unit and for calculating in terms of value, it is fixed cost upon PV ratio. Now, this understanding of contribution PV ratio and BEP helps us in variety of decision situations. What are the decisions which are facilitated by this? Do you remember? Can you name a few decisions? Just try to think over. So, you can take pricing decisions. You can decide your level of activity. If the product or the raw material is in short supply, you can take sales mix decision. You can decide on whether to outsource or not to outsource. So, a variety of decisions are based on the understanding of CVP and BEP concepts. Let us try to do a few cases on these concepts. Now try to read this case carefully. It is a little longish one, but please be careful, read it properly. Very interesting case. So, for a company called as Devi Cosmetics, they have four products. The data is given about them, Gowri, Parvati, Uma and Suma. Number of units sold in the last quarter is available. It is 200, 250, 400, 400. Selling prices are 50, 40, 90 and 80. Raw material prices per unit, wages per unit, fixed cost per unit are all available. Now, in the current quarter, company wants to improve its product mix. So, company has decided to drop any one product temporarily. And the output of any other product will be used, will be increased. Kindly advise the company which product is to be dropped and which one is to be focused in the following scenarios. One, demand in units is restricted and the total sale units cannot be increased. Second, raw material is in short supply. Third, demand in rupees is restricted and total sale amount cannot be increased. Compute the profit for each of the situations if your advice is followed. Once again have a look at it and think over how it can be solved. Are you able to suggest how to proceed? Now, the first thing which we need to understand is company would like to improve its profits by improving the product mix. So, the idea is a product which is giving you less profits will have to be dropped and will focus on some product which is more profitable. So, we need to rank the products to know which product is more profitable and which product is less profitable. So, the most profitable one we can focus on we would like to increase its sales. Three decision situations are given. In first case, the demand in units is restricted. So, market is such that the total number of units sold are same. So, for Gowri it is 200, 250, 400, 400. So, we know the total market size. In that market size, we can move the output from one product to another. You will realize that we would like to rank the products, remove rank number 4 and transfer that output to rank number 1 because they have given a restriction that they cannot close all the products. They will close only one product temporarily and that output will be transferred to another product. So, now how will you start? For the starting, irrespective of the decision situations, we need to first calculate the contribution from each of the products. If you remember, we have discussed that it is not the profit, but it is the contribution that is really driving the profitability. So, let us see how to do it. So, in the beginning, using the available data, fixed cost is calculated. If you see here, our fixed cost was given in terms of per unit, it was 10, 5, 15 and 10. Now, this fixed cost, though they are given in terms of per unit, actually are not changing unit wise. So, instead of representing on per unit, it will be appropriate to show them as the total amount. So, in the beginning, we have calculated the total fixed cost. So, for Gavri, it is 10 per unit and there are 200 units of Gavri. So, we get 2000 as fixed cost. It is not fixed cost of Gavri. There is no point in dividing the fixed cost product wise. The total fixed cost will be more important and it will be treated as together. So, in the same manner, for Gavri, Parvati, Uma and Suma, the fixed costs are calculated and total, we get a total fixed cost of 13 to 50. Now, let us try to compute the contribution. So, what type of cost this fixed cost is? What is this decision? If you remember, we call such cost sunk cost. Because it does not affect our decision, we should not include it in taking the decision. That is why we have first calculated and we will remove it. We will not include in for taking the decision. Now, the contribution is calculated. We know the number of units. We also know the selling price and we know the data on variable cost. So, using this data, now the variable cost is first calculated. So, raw material price is 20 and 10. So, we get the total VC as 30. Our selling price is 50. So, 50 minus 30, the contribution is 20 per unit. Like that, so we have taken this sales price and we have taken the total of VC that together gives me an important figure of contribution. Same way, contribution is calculated for all the four products. So, it is 20, 10, 35 and 20. We have multiplied it by number of units. So, 20 into 200, you get 4000 as contribution from Gauri, 2500 from Parvati, 14000 from Uma and 8000 from Suma. So, total contribution is 28500 minus fixed cost of 13 to 50. Our current profits are 15 to 50. Now, from this profit position, the company would like to improve. That is why they are thinking of changing the product mix to a better one. Now, how will you proceed? Give them a suggestion. Is it that the product with the total contribution we would choose? Is it the product with higher per unit contribution we will choose? That we will have to see as per the decision situation. Now, situation 1, situation 1 says that the demand in units is restricted. Total sale units cannot be increased. Now, what to do in such scenario? So, our ranking would be based on contribution per unit. You can see here for the 4 products, we have already calculated this contribution. 20, 10, 35 and 20. The same has been repeated here. So, contribution is 20, 10, 35 and 20. So, the most profitable product undoubtedly is Uma because it has a contribution of 35. Then it is Gauri and Suma both have rank number 2 because they have a contribution of 20 each and Parvati has a contribution of 10. So, we have given it rank number 4. So, you can easily see that company should concentrate on Uma and would like to drop Parvati. So, decision says that drop Parvati and add units to Uma. Are you clear why this decision was taken? So, we have decided to focus on the product with highest contribution and the product with lowest contribution will be done away with. That is why Parvati is dropped and Uma with rank 1 will be focused on. Now let us look at profitability after this change. So, now the number of units for Uma have increased. If you see earlier Uma units were 400, Parvati units were 250. So, these 250 units are now transferred to Uma because total number of units are restricted. You can close a product and transfer it to another profitable product. So, Parvati's production is temporarily closed and it is transferred to Uma. So, we get 650 as the output of Uma. Gauri is 200, Suma is 400. The selling price, variable cost and contribution remains the same. So, 200 into 24000 is a contribution of Gauri as it has remained same. Parvati has become 0. Uma now has increased to 22, 750. Uma is again same 8000. So, if we take the total contribution, it is 34, 750. Fixed cost does not change. It is a sunk cost. So, now the profit is 21,500. So, has there been an increase in profit? What was the earlier profit? It was only 15 to 50. It has become 21,000. So, you can see that by this decision, we have increased our profit almost by 50 percent. So, almost by 7,250, we could increase the profit and reach 21,500. So, is it clear now how the calculation of contribution and use of CVP has led us to a better product mix? Now, let us look at decision situation 2. The decision situation 2 says that raw material is in short supply. Now, please advise me what should be done in such a scenario. If we have limited raw material, will the rank change now? How will you do the ranking? The rank will change because now the focus is on better usage of raw material. Earlier, we were looking at contribution per unit. If you see here, we looked at contribution per unit and it was used for ranking. Now, instead of contribution per unit, we will see contribution per value of raw material consumed or per rupee of raw material. So, let us see the recalculation. Now, we already have the number of units. We have contribution per unit, which is already done 20, 10, 35 and 20. Now, the contribution per RM consumed is calculated. You can look at the RM consumed, which is 20, I will just go up to this table. So, RM consumed was 20, 15, 30 and 45. The same is used here, I think I will insert the column, so that it is more apparent to you. Is it now more clear? So, contribution per unit was 20, raw material consumed is also 20 for Gavri. So, contribution per rupee of RM consumed is 1 for Gavri, for Parvati it is 0.66, for Uma it is 1.67 and Suma it is 0.44. So, now, you can see the ranking, Uma remains number one with highest contribution per use of raw material, Gavri is number two, Parvati is number three and Suma is number four. So, what is your decision now? So, now the decision is to drop Suma and add units to Parvati. So, we would like to focus on Uma. The focus continues and we would like to drop Suma. Why Suma dropped? Because it is giving me only 0.44 per rupee of raw material consumed, if the same raw material is transferred to a better product that is Uma, we would get more profits. Our beginning position was this, so I will copy that units and we would like to go for a better mix, correct. So, now, we have decided that Suma be closed and use that raw material to make Uma. So, what will be the new units of Uma, will there be 400 plus 400 of Suma? Now, in situation one, we could do that because number of units were to be transferred. In this case, it is not number of units, but it is the raw material that is to be transferred. So, we will have to see how much raw material was consumed by Suma. That raw material will be released and it will be transferred to Uma. So, are you able to now see how much raw material will be released? We will try to do it here, I think that will be giving you more clarity. So, how much raw material was released by not making Suma? So, we are not worried about the first two products, but if you look at Suma, which now we want to close, how much was the raw material being consumed by Suma? I will paste the values, so that there are no changes. So, now you can see that by not making one unit of Suma, I am saving 45 per unit and such 400 units of Suma were manufactured. So, raw material released from Suma is now 18,000 kgs. If same 18,000 kgs is transferred to Uma, how much of Uma units you can make? Because Uma consumes only 30 kgs per unit. So, you can perhaps make 18,000 upon 30, so you can make additional 600 units of Uma. So, by not making 400 units of Suma, actually this 400, we are able to release raw material of 18,000, so this is raw material released. So, RM consumed for Suma will be now released and it will go to Uma. So, we get additional 600 units in Uma. So, now in a new chart for Suma it will be 0 and for Uma it will be 400 plus 600. So, this is a new table. So, again let us make a table of profitability. Now, we show Uma units as 0, Suma units as 1000. For Gavri and Parvati, there are no changes, we have already calculated contribution per unit. So, contribution of Gavri, Parvati remains at 4000 and 2500. For Uma, the contribution has significantly increased to 35,000, Suma is 0, so total contribution is now 41 500 minus fc of 13 250, so profit is 28 250. So, you can see how much increase in the profit. From the original profit of 15 250, if we reallocate the raw material carefully, the profitability zooms up to 28 250. Of course, we have assumed that there is enough demand for Uma. As per the condition, we can close any one product and that can be transferred to another product. So, we have closed Suma, same raw material transferred to Uma and with that raw material, we could make 600 more units of Uma which are sold. So, we get a profitability of 28 250 in situation 2. Now, situation 3. In situation 3, it was given that demand in rupees is restricted, total sale amount cannot be increased. So, how much customers will buy is fixed? We cannot increase the total volume of sales. So, now how to proceed? How will you do the ranking in this scenario? Just think over. So, in this scenario, it is not the contribution per unit, it is not contribution for raw material, but it is the contribution per rupee of sale that is contribution upon sales which in other words, we call it as PV ratio. So, here the ranking is based on PV ratio. Now, let us look at the ranks. So, again the original data is shown. The PV ratio is 0.4 for Gowri, 0.25, 0.3889 and 0.25. I hope you remember the formula for PV ratio. What is the formula? It is contribution upon sales or contribution per unit upon selling price. So, 20 upon 50, so we get 0.4, 0.25, 0.3889 and 0.25. So, the ranking has changed now completely. You can see now the Gowri, product Gowri has ranked number 1, product Uma closely follows it. It has ranked number 2 and Parvati and Suma both have ranked number 4. So, in this scenario, what decision would you like to take? So, we would like to drop either Parvati or Suma, but which one is better to be dropped? In this case, you can see Suma has been dropped, but why? So, you would appreciate that if you would look at the starting point. This was our table. We know that Gowri is the most profitable product in terms of PV ratio. Parvati and Suma both have ranked number 4. So, of the two, which one you would like to drop? You will see that more sale revenue comes from Suma. So, it is 400 units at a price of 80. So, if we close Suma and transfer the output to Gowri, that will give us more sales totally and that will also give us more output. So, let us try to calculate it once again. So, if you start with the original scenario, where it was this many units, you will realize that our profit was 15 to 50. This is like a original table. What we have done more is we have calculated the contribution, PV ratio, then we have calculated the ranks. Now, our decision is based on this rank, what to do? So, we will decide that it may be better to drop Suma and add those units to Gowri. Is it clear to all? Why we have dropped Suma only? That is because Suma has more sales than Parvati. So, though both have rank number 4, our decision is based here, not only on ranks, it is also based on the quantum of sales. I think I will show you that we will make it more clear. So, let us try to calculate the sales for all the 4 products. So, you will realize that sales of Suma are much more than those of Parvati. So, it might be better to close Suma and transfer the whole output to another product that is Gowri. Is it correct? Now, how much of units of Gowri can be sold? You know that the total sale value cannot increase. So, total sale value of Suma that is 32000 will be now transferred to Gowri, but their sale prices are different. So, we will have to calculate how many more units can be sold. So, I am just copying the same table again so that we can correctly calculate the more number of units which can be sold. So, 32000 is the reduction in Suma sales. We will not worry about Parvati and Suma now. So, Suma sales will reduce by 32. If I put that 32 here in Gowri at the rate of 50 per unit, how many more units can be calculated? I can make 640 more units of Gowri. I already have output of 200 for Gowri, I will add 650. So, I get total output of 840 for Gowri and Suma's output will become 0. So, again it is not that 400 units are transferred from Suma to Gowri. It is a sale value of 32 which is transferred from Suma to Gowri. We will have to calculate the new units which can be produced. So, we have done the calculation and we get 640 more units. So, now we have 840 units of Gowri and 0 units of Suma. If you do all the recalculation again, you will get that it is a extra contribution of 32000. So, it is a total contribution of 32 now, fixed cost remains same. So, profit has now reached 20,000, 0, 5, 0. Is it clear now? In all the three decision situations, our ranking criteria were different. So, first situation was if total sale in units are restricted. What was the ranking criteria? The ranking was based on contribution per unit. The second scenario, the raw material consumption or raw material availability was restricted. So, what was the ranking criteria? It was contribution per rupee of raw material. In third, the total sale value was restricted. So, what was the ranking criteria? Here the ranking criteria is based on PV ratio. So, like that company will have to look at their scenario and then find out what is a suitable ranking criteria. But one thing is very clear that appropriate ranking criteria once chosen, CVP ratio tells you how you can improve your product mix and you can see the profitability has improved in all the three scenarios. Now, let us look at case number 2. I will request you to read it carefully. So, now a company called Walmicki limited manufactures product P through department 1 and 2 and following are the details of product P which are available. So, they have given two departments. It passes through department 1 and department 2. Raw material cost is given for both the departments. Consumption in kgs is given, direct labour hours are given, direct labour rate is given and then I am sorry this should be direct labour rate per hour. It is not per unit, it is per hour. So, you can see raw material cost per kg is 4 and 2 and the consumption is 2 and 3. Direct labour rate per hour is 2 and 4 and number of labour hours is 1 and 2 and fixed expenses are given per unit as 15 and 6. The volume of 10,000 units is sold at 100. You have to calculate a break even point in both units and rupees, calculate the profit for current level and what will happen if demand falls by 50 percent and also calculate margin of safety in amount and percentage. So, how to go about now? Let us think over how we can proceed. So, are you able to find out what can be done? Actually here there is no purpose of giving units separately. There was no reason why two departments must be given. Even if the data is given for two departments, you can combine the data and proceed. So, we would try to calculate the variable cost for the product which will give me contribution per unit and PV ratio. Using that data, we can calculate BP and what do you mean by MOS? Do you remember MOS is margin of safety. Once we get BP, we can calculate MOS. Now, from the available data, the first thing we are trying to calculate is the raw material cost. We are consuming 2 kg and price is 4 per kg. So, anyway 4 into 2, we will get 8 as the raw material cost for in department 1 and 2 into 3 that is 6 is the raw material cost in department 2. So, total RM cost comes to 14, 6 plus 8. Same way for labour multiply 5, 1, 4, 2. So, we get 5 and 8. The total labour cost is 13. So, 14 and 13. So, we get the total variable cost as 27. This is variable cost per unit. In most of the PV ratio problems or BP problems, it is very important for you to arrive at variable cost per unit. This we will compare with selling price which is given as 100. So, selling price is 100, variable cost is 27. So, contribution is 73. I hope these fundas are very clear to you now. Now, once you know contribution, we can calculate BP, but before that we need to know the fixed cost. So, how much is the fixed cost? It cannot be just 15. 15 per unit in department 1, we know the number of units. So, what we have done is 15 plus 6. So, it is 21 per unit and the volume is 10,000. So, we get 21 into 10,000, 2 lakh 10,000 as a fixed cost, break even point, we can calculate it now. So, what is the formula for break even? Yes, you can tell me it is FC upon contribution per unit, correct. So, fixed cost is 210 divided by 73, you get 2876 as a contribution per unit. This is a break even point in terms of units, sorry 2876 is a break even point in units, contribution per unit is 73. Same way calculate PV ratio. What is the formula for PV ratio? You are right, I think you are getting it correct. It is contribution upon contribution per unit divided by selling price. You can also do it as contribution upon total sales, but here we know per unit contribution and selling price. So, it is 73 upon 100, we get 0.73. Break even point in rupees will be, what is the formula, FC divided by PV ratio, correct. So, FC is 210 divided by 0.73, we get 287671. So, first part of the question said that calculate BEP in units and rupees that we have solved it now. The second part says calculate the current profit and the profit if demand falls by 50 percent. So now, how will you calculate the profit? We know the contribution and FC both, so calculating the profit is very simple. Contribution will be 730,000, so it is 73 per unit for 1000 units, so 730 is a contribution, I am sorry 10,000 units, so 73 into 10,000, 730,000, fixed cost is 21 into 10,000, so 2,10,000 and profit is 5,20,000. Now, what will be the scenario, if demand falls by 50 percent, how much will be the profit, will it also fall by 50 percent, no. Because fixed cost does not change with level of activity, contribution does. So, let us recalculate the contribution, so for contribution now per unit it remains at 73, but number of units have fallen to 5000, so contribution also comes to half, it becomes 365,000, fixed cost remains at 210, so profit has significantly dropped it is 1,55,000. So, we have also done the second part of the problem, calculate the profit for current level and if demand falls by 50 percent. Now the third part, calculate MOS in amount and percentage. What is MOS, what is its formula, are you able to remember, margin of safety means how much above the current level sales, how much is the current level sales above the BEP, so this is BEP minus current sales or minus sales you can say. Now you know that your current sales are at 100 per unit for 10,000 units, so your current sales become 100 into 10,000 that is 10 lakhs. The breakeven point in terms of rupees is 287,671, here we had done it, so 10 lakh minus 287,000, we get margin of safety as 712,329, it is a very healthy margin and we can also calculate it in percentage terms, so what is the formula for doing it in percentage terms? It is MOS that is margin of safety divided by sales, so MOS is 712 upon 10 lakhs, so we get 0.71 as MOS in percentage. Now, let us do one more case, so here we were trying to revise a very basic fundage on BEP PV ratio and MOS, if you are able to do it very easily very fine, because now we have done number of problems, so it is intended that you can easily handle this simple problems. Now let us take the third one, now methai is a product which can be calculated by two methods, either by automated or by handmade, the sales data for both the methods is given, automated is 15 lakhs, handmade is 10 lakhs, then the variable cost, fixed cost is given, fixed cost also includes interest, for automated it is 1 lakh and for handmade it is 50,000, so read this carefully, what we have to calculate? We have to calculate PV ratio and BEP in both the cases, we have to calculate cost in difference point, then compute the profit at the current level and at such level by both the methods, so by at such level we mean at cost in difference point level, so compute the current profit and the profit at cost in difference point, calculate the PV ratio and BEP at such level by both the methods, that is by automated and by handmade method, compute the operating leverage, financial leverage and the total leverage for both the levels of activities again by both the methods, so now how to do it? We have done all these fundas, so just try to remember how we can proceed, do you remember what is cost in difference point? Even before that we will calculate PV and BEP, that I think all of you can easily calculate, so if this is the data which is available, how will you calculate PV ratio and BEP? What is the formula of PVR? I think most of you will know it by now, but I am just showing it again for the benefit of those who do not remember it, so it is contribution upon sales, in this case we do not have per unit level data, so we are doing it on total basis, so we need to know contribution, sales is given, how much is contribution from the given data, contribution is nothing but sales minus variable cost, so it is 11 lakhs and 10 lakhs, so PV ratio is contribution 11 lakhs upon sales 15 lakhs, 0.73 and for handmade it is 0.4, so you can see that automated technology gives us more PV ratio, but it has higher fixed cost associated with it, fixed cost are 9 lakhs, whereas in handmade the PV ratio is low just 0.4, but fixed cost also remain low, now the question was calculate the PV ratio and BEP, so how much is BEP now, again what is the formula for BEP, it is FC divided by PV ratio, so we know that fixed cost is 9 lakhs divided by PV ratio, so it is 12,27,000 for automated system and it is 7,50,000 for handmade system, why it is lower for handmade system, it is natural because the fixed cost are lower for handmade system, so we have done the first calculation that is BEP up to BEP, now let us try to do the calculate the cost in difference point, so what is cost in difference point, do you remember and do you remember its formula, earlier we have done this, so in cost in difference point the idea is that to calculate such level of sales, where the profits are constant by use of both the technologies, so either you go by automated or handmade the profits should be same and what is that sales level where the profits are same that is known as cost in difference point, so what we will do is the formula is very similar to the BEP formula, BEP formula as you know is a pv ratio, here we try to find difference in fc and divided by difference in pv ratio, so it is difference in fc upon difference in pv ratio, now we know the fixed cost for both the methods, so try to find the difference between the two, it is 6 lakhs and the difference between pv ratios is 0.33, so the cost in difference point will be 6 lakhs upon 0.33 that is 18 lakhs, so 18 lakh is such level of sales where by either method the profit will be constant, so in today's session we have started doing a sort of revision on decision making CVP break even point, we have seen what is meant by contribution, we have seen what is meant by break even point, what is meant by pv ratio and we have done two interesting cases, the first one was on product mix under different scenarios, so if raw material is restricted, if sale is restricted how you can improve your product mix using calculation of contribution per unit or per rupee of raw material that we have seen, second sum we had two departments, but the departments were irrelevant we had to just calculate the variable cost pv ratio and so on, in the third sum the focus is on calculation of cost in difference point, so we have done it in today's session, in next session we will continue the sum, we will calculate the cost in difference point and profitability at that in difference point, thank you so much.