**Marginal Cost**

**:**

Marginal
cost is the additional cost of producing an additional unit of a product.
Marginal cost is defined by I.C.M.A, London as ‘the amount at any given volume
of output by which aggregate costs are changed if the volume of output is
increased or decreased by one unit. In practice, this is measured by the total
variable costs attributable to one unit”.

**Cost-Volume-Profit Analysis:**

Cost-Volume-Profit analysis is
analysis of three variables i.e., cost, volume and profit which explores the relationship existing amongst
costs, revenue, activity levels and the resulting profit. It aims at measuring variations of
profits and costs with volume, which is significant for business profit
planning.

CVP analysis makes use of
principles of marginal costing. It is an important tool of planning for making
short term decisions. The following are
the basic decision making indicators in Marginal Costing:

(a) Profit Volume Ratio (PV
Ratio) / Contribution Margin ratio

(b) Break Even Point (BEP)

(c) Margin of Safety (MOS)

(d) Indifference Point or Cost
Break Even Point

(e) Shut-down Point

**Break-even Point:**

Break Even Point is the level of
sales required to reach a position of no profit, no loss. At Break Even Point,
the contribution is just sufficient to cover the fixed cost. The organisation starts earning profit when
the sales cross the Break Even Point.
Break Even Point can be calculated either in terms of units or in terms
of cash or in terms of capacity utilization. It can be calculated as follows:

BEP in units = Fixed Cost /
Contribution per unit

BEP in cash = Fixed Cost / P.V.
Ratio

BEP in terms of capacity
utilization = (BEP in units / Total capacity) x 100

Profit-Volume Ratio expresses the
relationship between contribution and sales. It indicates the relative
profitability of diff products, processes and departments. Higher the P/V
ratio, more will be the profit and lower the P/V ratio lesser will be the profit.
Hence, it should be the aim of every concern to improve the P/V ratio which can
be done by increasing selling price, reducing variable cost etc.

It can be calculated as follows:

P/V ratio = (S – VC)/ S X 100

= Cont / Sales X 100

= Change in profit or loss /
Change in sales

*Uses of P/V Ratio:*
1. To compute the variable costs for any volume of sales.

2. To measure the efficiency or to choose a most profitable line.
The overall profitability of the firm can be improved by increasing the
sales/output of a product giving a higher PV ratio.

3. To determine break-even point and the level of output required
to earn a desired profit.

4. To decide more profitable sales-mix.

**Break-even chart:**

The break-even chart is a graphical representation of cost-volume
profit relationship. It depicts the following:

a)
Profitability
of the firm at different levels of output.

b)
Break-even
point - No profit no loss situation.

c)
Angle of
Incidence: This is the angle at which the total sales line cuts the total cost
line. It is shows as angle Θ (theta). If
the angle is large, the firm is said to make profits at a high rate and vice
versa.

d)
Relationship
between variable cost, fixed expenses and the contribution.

e)
Margin of
safety representing the difference between the total sales and the sales at
breakeven point.

*Different types of Break-even charts*
a)
Contribution
Breakeven Chart: This chart shows contribution
earned by, the firm at different levels of activity.

b)
Cash
Breakeven Chart: In this chart variable costs are
assumed to be payable in cash. Besides this the fixed expenses are divided into
two groups, viz. (a) those expenses which involve cash outflow e.g. rent,
insurance, salaries, etc. and (b) those which do not involve cash outflow. e.g.
depreciation.

c)
Control
Breakeven Chart: Both budgeted and actual cost
data are depicted in this chart. This chart is useful in comparing the actual
performance of the firm with the budgeted performance for exercising control.

d)
Analytical
break even chart: This chart shows the break-up of
variable expenses into important elements of cost. Viz. direct materials,
direct labour, variable overheads, etc. Also the appropriations of profit such
as ordinary dividends, preference dividend, reserves, etc. are depicted in this
chart.

e)
Product
wise break even chart: Separate break-even charts for
different products can also be prepared to compare the profitability of the
products or their contribution.

f)
Profit
graph: Profit graph is a special type
of break-even chart, which shows the profits or loss at different levels of
output.

*Limitations of break-even chart*
a)
The variable
cost line need not necessarily be a straight line because of the possibility of
operation of law of increasing returns or decreasing returns.

b)
Similarly
the selling price will not be a constant factor. Any increase or decrease in
output is likely to have all influence on the selling price.

c)
When a
number of products are produced separate break-even charts will have to be
calculated. This poses a problem of apportionment of fixed expenses to each
product.

d)
Break-even
charts ignore the capital employed in business, which is one of the important
guiding factors the determination of profitability.

The positive difference between the sales volume and the break
even volume is known as the margin of safety. The larger the difference, the
safer the organization is from a loss making situation. It can be calculated
either in cash or in units.

Margin of Safety can be derived as follows:

Margin of Safety = Actual Sales – Break
even Sales or,

Margin of Safety (in cash) = Profit / P/V
Ratio

Margin of Safety (in units) = Profit /
Contribution Per unit

**Angle of Incidence:**

Angle of
incidence is an indicator of profit earning capacity above the break-even
point. A wider angle will indicate higher profitability, while a narrow angle
will indicate very low profitability.

If margin of
safety and angle of incidence are considered together, they will provide
significant information to management regarding profit earning position of the
undertaking. A high margin of safety with a wider angle of incidence will
indicate the most favourable condition of the business.