Profit Planning

Profit Planning: A business concern exists with the objective of making profits, and profits are the yardstick of its success profit planning is therefore a part of operations planning. It is the basis of planning cash, capital expenditure, and pricing. If growth and survival of a business are to be ensured, profit planning becomes an absolute necessary. Marginal costing assists profit planning through computation of contribution ratio. It enables planning of future operation in such a way as to either maximize profits pre maintain specified levels of profit. Normally, profits are affected by several factors, such as the volume of sales, marginal cost per unit, total fixed costs, selling price and sales mix etc., Hence management can achieve their profit goals by varying one or more of the above variables. Basic marginal costing equations which are useful in profit planning are as follows.

Profit volume ratio (p/w ratio). This is the ratio of contribution to sales. Symbolically it is expressed as:

Contribution

C/S ratio or P/V ratio = ——————————— x 100                (1)

(as a percentage)                 Sales (S)

Contribution = Sales x P/V ratio                                                               (2)

Contribution

Sales = ————————–                                                             (3)

P/V ratio

Brake Even point (BEP). This may be defined as that point of sales volume at which total revenue is equal to total costs. it is a no-profit no-less point. It may be derived from the equation (3). We may get

Contribution at BEP

BEP (in Rs.)              —————————–

P/V ratio

At BEP, the contribution will be equal to fixed cost and therefore, the formula may be restructured as follow:

Fixed Cost

BEP (in Rs.)  =          —————————

P/V ratio

Fixed Cost (F)

BEP (in units) =        —————————–

Contribution per unit

Margin of Safety (MS) : This represents the difference between salew or production at the selected activity, and the break-even sales or production.

MS  = Sales at the selected activity   — BEP

C

Sales at the selected activity  =   ———————-

P-V ratio

F

BEP  =                        ———————-

P/V ratio

C                                             F                                  profit (p)

MS  =  ————————- ————   ——————- = —————————

P/V ratio                                          P/V ratio                     P/V ratio

Where C-F = P

Margin of safety is also presented in percentages as follows:

MS (Sales) x 100

—————————————–

Sales at selected activity