Question

In a minimum of 175 words. Explain CVP. How is the Breakeven point related to CVP? What are the benefits of CVP and what are the weaknesses in the method? Is CVP too simplistic to be used in today's changing business environment? Note the definition of simplistic - i.e. overly simplified. Why or why not?

Answer 1

CVP analysis is cost volume profit analysis. It helps in understanding the relationship between cost incurred in an organisation with volume and profitablity at different levels of activity. Break even analysis is one of the analysis of CVP. Breakeven point is the point at which there is no profit or no loss. In other words at Breakeven point contribution is equal to fixed cost and profit or loss is nil.

Benefits of cvp analysis:

· It helps in various decision making like continue or discontinue division or product, launching new products, pricing decisions, etc

· It helps in preparing profitablity at different levels of activities

· It helps in implementation of budgeting system in an organisation

· It helps in cost management through cost control and cost reduction

Weakness of cvp analysis:

· It assumes all costs can be classified in to fixed cost and variable cost. Practically it is difficult to classify all costs.

· Cost can be driven by factors other than volume. For example inflation, government regulations, technological changes etc

· Cvp analysis is difficult to apply in multi-product situations.

CVP analysis works with a lot of assumptions. Hence it is over-simplified when those assumptions are considered in today’s changing business world. Nevertheless cvp analysis is still useful when combined with other techniques like sensitivity analysis, simulation, etc to give best input for decision making.