The CVP analysis helps in taking more than one decisions in a firm. How would you substantiate this statement for a unit under expansion phase| |
Companies commonly face major uncertainties in their product markets, particularly in the manufacturing industry where competition is often fierce and consumer tastes change rapidly. Managers need to estimate future revenues, costs, and profits to help them plan and monitor operations and to decide the mix and volumes of goods or services to produce and sell. They also use this information to evaluate profitability risk. Cost-volume-profit (CVP) analysis is the technique used to identify the levels of operating activity needed to avoid losses, achieve targeted profits, plan future operations, decide on expansion or contraction plans, monitor organizational performance and analyze operational risk as they choose an appropriate cost structure to help in the decision making process to sustain the firm.
Table of Contents
Marginal Cost Equations and CVP Analysis9
Cost Volume Profit (CVP) Relationship in Graphic Form14
Applications of Cost Volume Profit (CVP) Concepts17
CVP Analysis Illustrations - Unit in Expansion Mode19
To assist planning and decision making, management should know not only the budgeted profit, but also: * the output and sales level at which there would neither profit nor loss (break-even point) * the amount by which actual sales can fall below the budgeted sales level, without a loss being incurred (the margin of safety) In marginal costing, marginal cost varies directly with the volume of production or output. On the other hand, fixed cost remains unaltered regardless of the volume of output within the scale of production already fixed by management. In case if cost behaviour is related to sales income, it shows cost-volume-profit relationship. In net effect, if volume is changed, variable cost varies as per the change in volume. In this case, selling price remains fixed, fixed remains fixed and then there is a change in profit. Being a manager, you constantly strive to relate these elements in order to achieve the maximum profit. Cost – Volume profit Analysis is a logical extension of Marginal costing. It is based on the same principles of classifying the operating expenses into fixed and variable. CVP analysis is generally defined as a planning tool by which managers can evaluate the effect of a change(s) in price, volume, variable cost or fixed cost on profit. Additionally, CVP analysis is the basis for understanding contribution margin pricing, related short-run decisions, target costing and transfer pricing. Apart from profit projection, the concept of Cost-Volume-Profit (CVP) is relevant to virtually all decision-making areas, particularly in the short run. The relationship among cost, revenue and profit at different levels may be expressed in graphs such as breakeven charts, profit volume graphs or in various statements forms. CVP Analysis helps managers understand the interrelationship between cost, volume, and profit in an organization by focusing on interactions among the following five elements: 1. Prices of products
2. Volume or level of activity
3. Per unit variable cost
4. Total fixed cost
5. Mix of product sold
Earning of maximum profit is the ultimate goal of almost all business undertakings. Profit depends on a large number of factors, most important of which are the cost of manufacturing and the volume of sales. Both these factors are interdependent. Volume of sales depends upon the level of production i.e. volume of production and market forces which turns in related to costs. Management has no control over market. In order to achieve certain level of profitability, it has to exercise control and management of costs, mainly variable...