After reading this article you will learn about Profit/Volume (P/V) Graph:- 1. Meaning of Profit/Volume Graph or Profit Chart 2. Method of Constructing P/V Graph.
Meaning of Profit/Volume Graph or Profit Chart:
A P/V Graph expresses the relationships between profit and volume. Its usefulness is to show a direct relationship between profit and the volume of sales. While contracting this graph, different lines for costs and revenues are omitted here since profit points are plotted only. As such, it will be more easy to understand the relationship between profit and volume.
Needless to mention here that this graph can be drawn if any two of the following data are obtained: viz:
(a) Fixed Cost;
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(ii) BEP;
(iii) Profit at a given level of activity.
In this graph, sales volume is depicted on the horizontal line and profit or loss on the vertical line. The profit line is plotted by determine the profit or loss, i.e., difference between sales and total cost, at each volume and BEP is that point where the profits line intersects the horizontal line.
Method of Constructing P/V Graph:
(a) Determine an appropriate scale for sales volume on the horizontal axis (which forms the sales line) and this line must be drawn up in the middle portion of the graph so that profit can be shown on the side above the sales line and loss or fixed cost below the sales line.
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(b) Then select a scale for profit and loss (fixed cost) on the vertical axis. Thus, the total fixed costs are shown below the sales line on the left hand side of the vertical axis and profits are shown on the right hand side above the sales line of the graph.
(c) Now, points are plotted for profits and fixed costs which are connected by a straight line which again intersects the sales line at the horizontal axis. And BEP is the point of intersection.
The following illustration will make the above principle clear:
Illustration:
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From following data prepare a P/V Graph:
Solution:
Before constructing a P/V graph, it becomes necessary to determine the amount of profit at the present activity level which is as under:
From the above, it becomes clear that the BEP is Rs. 62,500 and Margin of Safety is Rs. 37,500. From the discussion we have made so far about the P/V Graph, we have found that a P/V Graph helps us to determine the BEP and its impact on profits at various levels of activity. It also highlights relative profitability under conditions of high or low demand for a product, for different product prices etc.
Some of them are discussed below:
(i) Relative Profitability under conditions of high or low demands: In order to show the relative profitability, the position of two separate firms can be taken into consideration.
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Illustration:
Two business X Ltd. and Y Ltd. sell the same type of product in the same type of market.
Their budgeted Profit and Loss Account for the year ending 1994 are as follows:
You are required to:
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(i) Calculate the BEP of each business; and
(ii) State which business is likely to earn greater profits in con editions of;
Heavy demand for the product;
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Low demand for the product
Solution:
(ii) From the above, we find that the total cost of both the firms X Ltd. and Y Ltd. are the same but fixed cost of X Ltd is comparatively low than the firm Y Ltd. As such, BEP of X Ltd. will come sooner which can be shown with the help of the following P/V Graph.
From the above graph, it becomes crystal clear that X Ltd. will earn more profits than Y Ltd. against a demand below Rs 1, 50,000 sales since the BEP has been reached sooner in case of X Ltd. Moreover, at volume of Rs. 1, 50,000 both the firms will earn equal amount of profit.
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But as the rate of earning profit in case of Y Ltd. is more in comparison with X Ltd (which is proved by Angle of Incidence) for a Volume above Rs. 1,50,000 Y Ltd. will earn more profit than X Ltd.
Thus:
(i) In case of heavy demand Y Ltd. will earn more profit, and
(ii) In case of low demand, X Ltd. will earn more profit.
(b) For various product prices:
Under the circumstance, a profit chart depicts the effect on BEP for charging different prices for a product. One is to remember that the use of units is needed as different prices are compared. The following illustration will explain the principals clearly with the help of a profit chart.
Illustration:
Solution:
Now, the following P/V Graph for different price may be constructed:
