Question

DOES CVP ANALYSIS APPLY TO SERVICE INDUSTRIES?

Answer 1

YES CVP ANALYSIS APPLY TO SERVICES INDUSTRIES,

AS CVP ANALYSIS IS ANALYSIS OF RELATIONSHIP AMONG COST INCURRED, PROFIT EARNED(LOSS SUFFERED) AT DIFFERENT LEVEL OF VOLUME OF SALE. IT APPLIES TO PRODUCTION SECTOR AND SERVICE INDUSTRIES BECAUSE IN ANALYZING CVP WE NEED ONLY TO DISTINGUISH TOTAL COST INCURRED INTO TWO CATEGORIES THAT IS VARIABLE COST AND FIXED COST AT DIFFERENT LEVEL OF SALES VOLUME. SO IT IS SERVICE INDUSTRY OR PRODUCTION INDUSTRY WE ONLY WANT SELLING PRICE, VARIABLE COST AND FIXED COST. THERE MAY DIFFERENCE OF TYPES OF COST TO BE INCLUDED IN FINDING THESE COSTS AND VARYING COMPLEXITIES IN CALCULATING THE COMPONENTS OTHER WISE BASIC METHODS AND CRITERIA REMAINS SAME

WE MAY TAKE EXAMPLE OF AMUSEMENT PARK IN NEW YORK WHERE ENTRANCE FEE IS $20 PER PERSON AND VARIABLE COST INCURRED IS $12 PER VISITOR AND FIXED COST PER YEAR OF THE PARK IS $100000. PARK WANTS TO KNOW THE BREAK EVEN SALE IN DOLLARS AND UNITS. SO HERE WE APPLY CVP ANALYSIS AS FOLLOWING.

CONTRIBUTION = SELLING PRICE - VARIABLE COST

= $20-$12

= $8

CONTRIBUTION MARGIN RATIO = $8*100/$20

= 20%

BREAK EVEN SALE IN NO. OF VISITOR REQUIRED = FIXED COST/CONTRIBUTION PER UNIT

= $100000/$8

= 12500 VISITORS

BREAK EVEN SALE IN DOLLARS = FIXED COST/CONTRIBUTION MARGIN RATIO

= $100000/20%

= $500000

SO WE FIND THAT WE CAN ALSO APPLY CVP ANALYSIS TO SERVICE INDUSTRIES

SOME MORE DISCUSSION ON CVP ANALYSIS IS AS FOLLOWING

UNDER CVP ANALYSIS WE ASSUME THAT VARIABLE COST PER UNIT AND SELLING PRICE PER UNIT WILL REMAIN CONSTANT FOR THE PERIOD OF ANALYSIS OTHERWISE WE HAVE TO SUITABLY ADJUST OUR CALCULATION TO REACH AT DESIRED RESULT. IN CVP ANALYSIS ALL VARIABLE COSTS INCURRED ARE TREATED AS PRODUCT COST AND FIXED COST IS CONSIDERED AS PERIOD COST. FOR CALCULATION OF PRODUCT COST PER UNIT FIXED COST IS NOT CONSIDERED. THE WHOLE FIXED COST IS CHARGED TO REVENUE OF THE YEAR IN WHICH IT IS INCURRED AND NO PORTION OF FIXED COST IS CARRIED FORWARD TO NEXT YEAR BY WAY OF INCLUSION IN THE VALUATION OF CLOSING STOCK

UNDER CVP ANALYSIS FIRST OF ALL CONTRIBUTION MARGIN IS CALCULATED BY DEDUCTING VARIABLE COST FROM SALE OF THE PRODUCT OR SERVICE AND OUT OF THIS CONTRIBUTION FIRST FIXED COST IS COVERED AND IF ANYTHING REMAINS THAT IS PROFIT IF RESULT HAPPENS TO BE NEGATIVE THEN IT IS LOSS.

THE WHOLE CVP ANALYSIS IS BASED ON CONTRIBUTION MARGIN EQUATION AND CONTRIBUTION MARGIN RATIO WHICH IS CALCULATED AS FOLLOWING

CONTRIBUTION = SELLING PRICE - VARIABLE COST

CONTRIBUTION MARGIN RATIO OR PROFIT VOLUME RATIO = CONTRIBUTION*100/SALE

ALL OTHER FORMULAS FOR ANALYSIS OF CVP IS DERIVED FROM ABOVE TWO FORMULAS

FEEL FREE TO ASK ANY CLARIFICATION IF ANY REQUIRED KINDLY PROVIDE FEED BACK BY THUMBS UP IF SATISFIED IT WILL BE HIGHLY APPRECIATED

THANK YOU