Accounting for Managers: Interpreting accounting information for decision-making

MARKETING DECISIONS 109

This is equivalent to the sales in units of 35,000 at £20 selling price per unit.
However, if the business has a maximum capacity of 25,000 units, the limit of its
relevant range, this profitability may not be achievable and the cost structure of
the business reflected in the CVP relationship would have to be revised.
CVP can be understood through a graphical representation. Using the same
data, the CVP graph is shown in Figure 8.1. In this CVP diagram, the vertical
axis represents money (both revenue and cost) and the horizontal axis represents
volume (the number of units sold). Fixed costs are seen to be constant, as increases
in volume do not influence total fixed cost within the relevant range. Variable
costs are nil at zero level of activity and increase in proportion to that activity.
Total costs are the sum of variable and fixed costs. They begin above zero because,
even with zero level of activity, fixed costs are still incurred. Total revenue starts
at nil and increases with the volume sold.
As fixed costs remain constant, profit per unit will vary at different levels of
activity. The point at which the total cost line intersects the total revenue line is the
breakeven point. The breakeven point is shown by the dotted line and can be read
as the revenue required (£400,000) to sell a given volume (20,000 units) at a selling
price of £20 per unit. The area of profit is found to the right of the breakeven point,
between total revenue and total cost. The area of loss is found to the left of the
breakeven point, between total cost and total revenue. Note, however, that outside
the relevant range (shown in the diagram as between 10,000 and 25,000 units) cost
behaviour may be different and so the CVP diagram may have to be redrawn.
The breakeven chart shows the margin of safety. Themargin of safetyis a measure
of the difference between the anticipated and breakeven levels of activity. It is
expressed as a percentage:

margin of safety(%)=

expected sales−breakeven sales

expected sales

× 100

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

0 5,000 10,000 15,000 20,000 25,000 30,000

Units sold

£

Fixed costs

Variable costs

Total costs

Revenue

Relevant range

Breakeven point

Figure 8.1 Breakeven chart for XYZ Ltd