Cost Volume Profit Analysis (CVP Analysis)
* CVP analysis is a systematic approach of examining the relationship between the changes in volume, cost, revenue and profit. The main objective of this analysis is to establish what will happen to the financial results if a specified level of activity fluctuates. * This analysis is useful especially to plan the future production and sales activity that will enable the firm to maximize profit and at the same time it enables firms to determine the break-even point and the margin of safety of the firm. This information is important to ensure the survival of the firm in the short-run and also in the long-run. * BEP represents the minimum units that the company have to sell before it incurs losses. BEP is a no gain no loss situation where the total revenue is equal to total costs. * Margin of safety shows the maximum units that can be reduced before the company will incur a loss.
3.2 The assumptions underlying the CVP analysis
* Costs can be accurately divided into their fixed and variable elements * Unit variable cost and selling price are constant
* Fixed costs incurred during the period are charged as expenses for that period * Volume is the only factor that will effect the costs and revenues * Single product is sold or multi-products are sold in accordance with pre-determined sales mix * Efficiency and productivity will not change
3.3 The approaches
* Mathematical approach
- The formulae are developed from the following formula:
Net profit=Sales revenue –Total costs
- Break-even point (BEP) is the point of sales volume where the firm is not attaining any profit or loss.
* Contribution approach
- Contribution margin is the excess of total revenues over total variable costs. Unit contribution marginUCM=Selling price-Unit variable costs
* Contribution can be also be expressed as a ratio to sales and...
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