A CVP ANALYSIS OF INDIAN TYRE INDUSTRY: FIVE COMPANY ANAYSIS

The first law of any business enterprise is to make profit. If we eliminate profit, the enterprise is also liable to be eliminated. The profits depend upon many factors. The management must know the various factors that determine profit. The important factors determining profit are selling price, sales volume, variable cost per unit, fixed cost, sales mix etc. for analyzing the impact of these factors on profit, some techniques are available. One of the important techniques is C-V-P analysis.

C-V-P analysis is an extension of marginal costing. It is used to evaluate how costs and profits are affected by changes in the volume of production. When volume of production changes, cost also changes. Consequently profit changes. Thus the three factors – cost, volume and profit is known as cost volume profit analysis. As per the CIMA official terminology, C-V-P analysis is defined as “ the study of the effects on future profit of changes in fixed costs, variable cost, sales price, quantity and mix “. Managers use this technique extensively to determine the BEP and margin of safety.

OBJECTIVES AND USES OF C-V-P ANALYSIS

C-V-P analysis is the most important tool of profit planning due to the close relationship among cost, volume and profit. There is a relation between volume and cost per unit. The objectives or uses of C-V-P analysis are as follows:

1.    To forecast the profit accurately

2.    To help management in determining the pricing policies

3.    To evaluate the performance of the business

4.    To facilitate the preparation of flexible budgets

5.    To achieve cost control and cost reduction

6.    To help management in making decisions such as make or buy, shut down or not etc…

7.    To determine break even point

TECHNIQUES OF C-V-P ANALYSIS

There are basic two techniques of C-V-P analysis. They are : (a) contribution margin analysis, and (b) Break even analysis. The other technique is profit volume analysis.

CONTRIBUTION MARGIN ANALYSIS

By analyzing the contribution margin, it is possible to study the relationship among cost, volume and profit. For this, contribution margin ratio (profit volume ratio) is to be computed. Here it is very essential to understand the meaning of contribution margin or simply contribution.

CONTRIBUTION

Contribution is a very important concept in marginal costing. It is the basis of decision making and control. It is the profit in marginal costing. It refers to excess of sales over variable cost. It is not the final profit. Contribution is also known as “contribution margin” or “gross margin”.

Contribution covers fixed cost and profit. If contribution is more than the fixed cost, there is a profit. If contribution is less than fixed cost, there is a loss.

Contribution can be expressed as ‘per unit’ or in ‘total’. Contribution per unit is the difference between selling price per unit and the variable cost per unit. Total contribution is the difference between total sales value and total variable cost.

USES OF CONTRIBUTION (IMPORTANCE)

Contribution is a useful technique for planning and decision making. The following are the advantage of contribution:

1.    It helps in fixing the selling price

2.    It enables to determine break even point

3.    It helps to find out the profitability of various products, departments etc.

4.    It guides the management in selecting the profitable product mix or method of production

5.    It helps the management in taking make or buy decision

6.    It helps to determine the key factor

7.    It enables, the management decide whether to introduce a new product in the market

8.    It indicate the profit potential of a business enterprise

9.    It highlights the relationship among cost, sales and profit

MARGINAL COST EQUATION

We know that a sale is equal to total cost plus profit. Total cost is equal to variable cost plus fixed cost.

Contribution = sales – variable cost

(Or)

Contribution = fixed cost + profit

Fixed cost = contribution – profit

Profit = contribution – fixed cost

Variable cost = sales – contribution

BREAK EVEN ANALYSIS

Break even analysis is the most widely used technique of cost volume profit analysis. It establishes the relationship between cost and profit with sales volume. It is a method of presenting and studying the inter relationship among cost, volume of sales and profit at various levels of activity. The term break even analysis is interpreted in narrow as well as broad sense. In its narrow sense, it is concerned with finding out the break even point. BEP is the point at which total sales revenue is equal to total cost. It is the point of no profits no loss. In its broad sense, it means a system of analysis which is used to determine the probable profit at different levels of activity. It shows the behavior of cost and profit at varying levels of activity.

Car Heyel defines break even analysis as “ a method for studying the relationship among sales revenue, fixed costs and variable expenses as to determine the minimum volume at which production so can be profitable “. The break even analysis may be expressed in graph such as break even chart or in a form as follows:

Marginal cost statement

Sales                                                                xxx

Less : marginal cost:                                       

Direct material                       xxx

Direct labour                          xxx

Variable overhead                 xxx                xxx        

Contribution                                                 xxx

Less : fixed cost                                            xxx

Profit                                                              xxx

ASSUMPTIONS OF CVP ANALYSIS

CVP is based on the following assumptions:

1.    All costs can be separated into fixed and variable elements

2.    Variable costs vary in direct proportion to volume of output

3.    Fixed cost will remain constant at all volumes of output

4.    Selling price per unit remains constant

5.    In the case of multiple products, sales mix remains constant

6.    Productivity per worker and efficiency of plant etc…remain unchanged

7.    The general price level does not change

8.    The firm is able to sell all the units produced

9.    The only factor that affects costs and revenues its volume.

ADVANTAGES OR USES OF CVP ANALYSIS

Following are the important uses or applications of CVP analysis from the management point of view:

1.    It is useful in forecasting sales and profit

2.    It helps in the inter – firm comparison of profitability

3.    It brings out the effect of increase or decrease in fixed and variable costs on profit

4.    It helps to determine the selling price which gives a desired profit

5.    It helps to find out the volume of sales which gives a desired return on capital employed

6.    It is useful for determining costs and revenue at different levels of activity

7.    It is used in profit planning

8.    It is used to determine margin of safety

9.    It can be used to study the comparative plant efficiencies of the industry

10.It is applied in make or buy decision

11.It assists in the formulation of price policies

12.It serves as a useful tool for cost control

LIMITATIONS OF CVP ANALYSIS

1.    It is very difficult or impossible to separate costs into fixed and variable

2.    It assumes that fixed costs remain fixed for any level of production. But actually it will remain fixed only up to a certain level of activity

3.    It assumes that variable costs vary in direct proportion to volume of production. But the variable cost need not necessarily vary in direct proportion of output

4.    The assumption that only one product is produced or that sales mix remains constant is difficult to find in actual life

5.    When a number of products are manufactured, separate break even charts may be prepared for individual products. This necessitates the apportionment of fixed costs on an arbitrary basis

6.    The assumption that selling price remains constant is not valid

7.    Break even analysis completely ignores the capital employed in business

8.    It has limited application in the long range planning  

9.    It ignores marketing aspects and effects of government policies etc..which are necessary in decision making

10.It is difficult to handle selling such as advertisement and sales promotion in break even analysis

11.Semi – variable costs are completely ignored

12.It measures the relationship among cost, volume and profit at a given point of time. Thus it is a static analysis

BREAK EVEN POINT

The calculation of B.E.P is the foundation stone of break even analysis. Break even point is the point or level of activity at which the total cost is equal to total revenue. It is the point of no profits no loss. Thus it is equilibrium or balancing point. It is the point at which losses cease and profits begin. If sales go up beyond the BEP, firm makes a profit. If they come down firm incurs a loss.

CALCULATION OF BREAK EVEN POINT

There are two methods of calculating B.E.P. They are: (1) Algebraic method and (2) Graphic method (B.E.P chart)

Algebraic method:  Under algebraic method B.E.P is ascertained by using mathematical formula. The B.E.P can be in terms of ‘units’ or in terms of ‘rupee value’ or as a ‘percentage’ of installed capacity.

B.E.P in Units:  The following formula is used:

                            BEP output (units) = fixed expenses/contribution per unit

B.E.P in Rupees:  The following formula is used:

                                 BEP sales (rupees) = (fixed expenses*sales)/contribution

B.E.P in percentage of capacity: sometimes BEP is expressed as a percentage of installed or estimated capacity. It is calculated as follows:

                                        (B.E.P sales / capacity sales)*100

                                                            (OR)

               (Fixed cost / total contribution at estimated capacity)*100

Special notes to BEP :

SL NO	SITUATION	FORMULA
1	Calculation of output to earn desired amount of profit	(F+P)/C per unit
2	Calculation of sales value (rupee) to earn a desired profit	[(F+P)/c]*S

MARGIN OF SAFETY

The management may be interested in knowing the extent by which the sales is above the BEP. This is called margin of safety. It is the excess of actual or present sales over the BEP sales. It refers to the amount by which sales revenue can fall before a loss is incurred. It indicates the strength or weakness of an enterprise. A large margin of safety indicates the soundness of the business. It may be expressed in units, sales revenue or as a percentage of sales.

        Margin of safety = present sales – BEP sales

If it is to be expressed as a percentage of sales, the following formula is used:

        Margin of safety = [(actual sales – BEP sales) / actual sales] *100

PROFIT VOLUME RATIO

As already stated P/V ratio (contribution margin analysis) is a technique of cost volume profit analysis. It is the ratio of contribution to sales. It shows the relationship between contribution and sales. Here volume means sales volume. P/V ratio is computed as follows:

                       P/V ratio = contribution / sales

USES OF P/V RATIO

1.    It helps in comparing the profitability of various products. A high P/V ratio indicates high profitability and a low P/V ratio is a sign of low profitability.

2.    With the help of P/V ratio, the management can estimate sales, profit and variable cost of future operations

3.    It is useful in determining pricing policy and other managerial policies when there are ‘key factors’

4.    It is an important tool in managerial decision making. Profitability of product lines, product mix, production techniques etc… are measured by comparing their P/V ratio

5.    It helps in the determination of B.E.P. The formula is

                                 BEP = fixed expenses / P/V ratio

                                 Hence fixed expenses = BEP * P/V ratio

6.    It helps in determining sales volume required to earn a given profit. The formula is:

                                 (Fixed expenses=profit) / P/V ratio

7.    It helps in calculating margin of safety. The formula is:

                                 Margin of safety = profit / P/V ratio

                                                   (Or)

                                (Profit * sales) / Contribution

8.    It helps in calculating profit at any volume of sales. The formula is:

                         Profit = sales volume * P/V ratio = contribution – fixed cost

9.    It helps in determining the required selling price per unit. The formula is:

                                 Selling price = variable cost per unit / (100-P/V ratio)

10.It helps in ascertaining the variable cost for any volume of sales

CVP ANAYSIS ON INDIAN TYRE INDUSTRY

(5 SELECTED COMPANIES)

For the analysis of CVP I select five popular companies in the Indian tyre industry which are as follows:-

1)     Apollo tyres

2)     Falcon tyres

3)     J K tyres

4)     Ceat tyres

5)     MRF tyres

APOLLO TYRES

The C-V-P regarding data of the Apollo tyre company is explained below:-

2007 2008 2009 2010 2011 APOLLO TYRES total sales 478121.5 424698.3 454963.2 850982 600095.6 total variable cost 355275 327429.1 364093.2 499113.5 505254.7 Total fixed cost 76395.9 53535.5 68096.1 272757.5 100575.8 CONTRIBUTION 122846.5 97269.2 90870 351868.5 94840.9 PROFIT 46450.6 43733.7 22773.9 79111 -5734.9 P/V RATIO 25.693 22.903 19.973 41.348 15.804 BEP 2973.346 2337.475 3409.400 6596.547 6363.82 MARGIN OF SAFETY 1807.868 1909.507 1140.231 1913.2723 -362.869

 INFERENCES:

·       The company sale in increasing year by year whereas the variable cost of the company in not proportionately changing

·       The highest contribution for the company was in 2010 which is because of the variable cost amount is comparatively less to its sales

·       The profit of the company is declining because the fixed costs are increasing and contribution is decreasing

·       In 2011 profit goes to a negative figure because the both costs are increasing at its most peaking way

·       The highest benefit for the company shows during the year 2010 as the margin of safety is in the highest point

FALCON TYRES

The detailed analysis report of C-V-P regarding the company Falcon tires are given below:-

FALCON TYRES	2007	2008	2009	2010	2011
total sales	32365	49854	85485	84953	97819
total variable cost	54741.83	58897.7	151376	157679	188306.8
Total fixed cost	7867.6	8515	11279	15696	17632
CONTRIBUTION	-22376.83	-9043.7	-65891	-72726	-90487.8
PROFIT	-30244.43	-17558.7	-77170	-88422	-108119.8
P/V RATIO	-69.13897729	-18.1403699	-77.0790197	-85.607335	-92.505341
BEP	-113.7939887	-469.39506	-146.330350	-183.34877	-190.60521
MARGIN OF SAFETY	437.4439887	967.9350595	1001.180351	1032.87877	1168.79521

INFERENCES:

·       The sales of the company is consistently growing except in the year 2010 and the growth movement of variable cost is supporting the sales

·       The basic problem in the company is it is always showing a negative figure for the p/v ratio value and it leads the calculation of BEP also to a negative value

·       The company is going for a high loss year by year and not shows not even a single figure for as profit during the study years

·       The cost structure of the company should improve and re modification is very necessary to reduce the loss of the company

JK TYRES

the data analysis report of JK tyres according to C-V-P analysis shows the following results:-

J K TYRES	2007	2008	2009	2010	2011
total sales	319571	549032	395629	524757	613102
total variable cost	268904	456443	294466	456064	508551
Total fixed cost	46509	62164	49700	53199	56621
CONTRIBUTION	50667	92589	101163	68693	104551
PROFIT	4158	30425	51463	15494	47930
P/V RATIO	15.8546927	16.86404435	25.57016801	13.09044	17.0527906
BEP	2933.453261	3686.185751	1943.671234	4063.95814	3320.33633
MARGIN OF SAFETY	262.2567387	1804.134249	2012.618766	1183.61186	2810.68367

INFERENCES:

·      The growth and sales of JK tyres shows a good cost system adoption by the company.

·      The total fixed cost of the company is fluctuating at a reasonable rate only and the variable cost changes are almost purely according to the sales of the company

·      The highest BEP for the company showed at 4063.95814 during the year 2010

·      The best performance of the company is during 2011 at a highest margin of safety of 2810.68367 and the lowest performance on the basis of margin of safety shows during the year 2007

CEAT TYRES

The analyzed report of C-V-P of the company Ceat tyres are shown below:-

CEAT TYRES	2007	2008	2009	2010	2011
total sales	213477.81	260296.57	280747.6	346892.25	479234.31
total variable cost	199945.81	211300.35	238997.99	341066.89	411878.44
Total fixed cost	32567	31506.23	32956.06	32816.29	52273.24
CONTRIBUTION	13532	211300.35	41749.61	5825.36	67355.87
PROFIT	-19035	179794.12	8793.55	-26990.93	15082.63
P/V RATIO	6.338832125	81.17677079	14.87086978	1.67929955	14.0548931
BEP	5137.697191	388.1187893	2216.148786	19541.6535	3719.22003
MARGIN OF SAFETY	-3002.919091	2214.846911	591.3272143	-16072.731	1073.12307

 INFERENCES:

·       The sales of the company are consistently growing by considering any cost factors and the variable cost is also perfectly following the sales of the company.

·       The fluctuations in the fixed costs are absolutely reasonable towards the company except in some cases

·       The company is suffering from contribution losses because of its increased fixed costs and declining of contribution

·       The highest margin of safety which shows highest soundness of the company shows during 2008 and 2 years 2007 and 2010 shows even negative figures which denotes the high problems because of losses

MRF TYRES

MRF is the biggest and sound company in the Indian tyre industry and the market leaders of the tyre industry is also MRF tyre company. The company is enjoying high cost profit along with the financial profit and by the study it is understood that company is having a very good cost control and ascertainment system. The details of cost C-V-P of the company is shown below:-

MRF TYRES	2007	2008	2009	2010	2011
total sales	505420	573163	616406	810431	1064486
total variable cost	434904	499866	480185	688997	956437
Total fixed cost	53526	62641	74082	85010	95163
CONTRIBUTION	70516	499866	136221	121434	108049
PROFIT	16990	437225	62139	36424	12886
P/V RATIO	13.95196075	87.21184026	22.0992333	14.9838789	10.1503449
BEP	3836.450014	718.262564	3352.242994	5673.43078	9375.34648
MARGIN OF SAFETY	1217.749986	5013.367436	2811.817006	2430.87922	1269.51352

INFERENCES:

·       The sales of the company is showing very high consistency and growth in the industry

·       The variable cost of the company is going perfectly proportionate to the sales of the company and the fixed costs are fluctuating at very quiet reasonable manner

·       The profits of the company is very high compared to the other companies in the industry and highest cost profit shows during 2008

·       The company is enjoying very good soundness and the highest margin of safety shows during the year 2008 shows the ever record growth in the industry.

 

TYRE INDUSTRY AS A WHOLE

The Indian tyre industry deserves a lot of appreciations as they are effectively controlling the demands for the tyres with there supplies. The Indian tyre industry consists of very few sellers which can be counted in fingers. And for this cost study I select the best market leaders of the same industry and the following table and inferences pointed out the overall cost ascertainment and controlling efficiency of the industry as a whole.

	APPOLLO TYRES	FALCON TYRES	JK TYRES	CEAT TYRES	MRF TYRES
2007
total sales	478121.5	32365	319571	213478	505420
total variable cost	355275	54741.83	268904	199946	434904
Total fixed cost	76395.9	7867.6	46509	32567	53526
CONTRIBUTION	122846.5	-22376.83	50667	13532	70516
PROFIT	46450.6	-30244.43	4158	-19035	16990
P/V RATIO	25.693574	-69.13898	15.85469	6.33883	13.95196
BEP	2973.3466	-113.794	2933.453	5137.7	3836.45
MARGIN OF SAFETY	1807.8684	437.444	262.2567	-3002.92	1217.75
2008
total sales	424698.3	49854	549032	260297	573163
total variable cost	327429.1	58897.7	456443	211300	499866
Total fixed cost	53535.5	8515	62164	31506.2	62641
CONTRIBUTION	97269.2	-9043.7	92589	211300	499866
PROFIT	43733.7	-17558.7	30425	179794	437225
P/V RATIO	22.903129	-18.14037	16.86404	81.1768	87.21184
BEP	2337.4754	-469.3951	3686.186	388.119	718.2626
MARGIN OF SAFETY	1909.5076	967.9351	1804.134	2214.85	5013.367
2009
total sales	454963.2	854850	395629	280748	616406
total variable cost	364093.2	151376	294466	238998	480185
Total fixed cost	68096.1	11279	49700	32956.1	74082
CONTRIBUTION	90870	703474	101163	41749.6	136221
PROFIT	22773.9	692195	51463	8793.55	62139
P/V RATIO	19.973044	82.2921	25.57017	14.8709	22.09923
BEP	3409.4002	137.0605	1943.671	2216.15	3352.243
MARGIN OF SAFETY	1140.2318	8411.439	2012.619	591.327	2811.817
2010
total sales	850982	84953	524757	346892	810431
total variable cost	499113.5	157679	456064	341067	688997
Total fixed cost	272757.5	15696	53199	32816.3	85010
CONTRIBUTION	351868.5	-72726	68693	5825.36	121434
PROFIT	79111	-88422	15494	-26990.9	36424
P/V RATIO	41.348524	-85.60734	13.09044	1.6793	14.98388
BEP	6596.5474	-183.3488	4063.958	19541.7	5673.431
MARGIN OF SAFETY	1913.2726	1032.879	1183.612	-16072.7	2430.879
2011
total sales	600095.6	97819	613102	479234	1064486
total variable cost	505254.7	188306.8	508551	411878	956437
Total fixed cost	100575.8	17632	56621	52273.2	95163
CONTRIBUTION	94840.9	-90487.8	104551	67355.9	108049
PROFIT	-5734.9	-108119.8	47930	15082.6	12886
P/V RATIO	15.804299	-92.50534	17.05279	14.0549	10.15034
BEP	6363.8256	-190.6052	3320.336	3719.22	9375.346
MARGIN OF SAFETY	-362.86963	1168.795	2810.684	1073.12	1269.514

INFERENCES:

·       The MRF Company is the highest performing company in the industry of tyres for the last so many years.

·       The Falcon tyres is one of the suffering company in the industry during my period of study

·       The overall performance of the industry at its cost aspects shows that the industry is doing well but according to there full capacity

·       The cost system adopting by the companies should improve and tried to maintain an effective cost audit system to avoid the manipulations and mistakes in the cost related statements, actions and thereby the performance of the company.

·       Even some companies are showing negative figures also as margin of safety, which shows the weakness of the company. The margin of safety will exactly shows the cost strength of the company in terms  of P/V ratio and profit of the company.

·       The basic reasons for the cost losses in companies are due to high fixed cost expenses. As tyre industries are fully manufacturing units and highly fixed assets oriented the items under fixed expenses are also showing big amounts which cannot be satisfied with the contribution of the company

·       The variable cost of tyre industry is mostly depends upon the rubber prices and availability. If any deficiency occurred for the rubber according to its demand the variable cost will goes to a high amount which cannot be satisfy with the sales increase which will cause to reduction in contribution and again cause to a loss.

 

CONCLUSION

The tyre industry in India is performing well in the country but cannot be said as they are working in there at most efficiency. The companies in selected for the study shows that the industry is some what doing well as far as cost details are concern. The basic problems facing by the industry is the price changes in raw material rubber and the deficiencies in the raw materials implicate the basic reason for increasing the variable costs of the industry and through companies go to losses. The second basic reason is that the fixed cost problems, as this tyre industry is fully concentrating high-tech machines and fixed assets it will increase the cost elements to a great extent also driving the company to cost loss. The companies are showing profit in financial reports and showing losses in cost statements are because of in financial statements companies are accounting so many revenues beyond the sales revenue.