Question

The importance of using CVP analysis for businesses from managerial accounting perspective. The assignment needs to present how the CVP analysis is used and how its important for businesses. 700 words

Answer 1

Cost-volume-profit (CVP) analysis is a method of cost accounting that looks at the impact that varying levels of costs and volume have on operating profit. The cost-volume-profit analysis, also known as break-even analysis, looks to determine the break-even point for different sales volumes and cost structures, which can be useful for managers making short-term economic decisions.

In performing this analysis, there are several assumptions made, including:

· Sales price per unit is constant

· Variable costs per unit are constant

· Total fixed costs are constant

· Everything produced is sold

· Costs are only affected because activity changes

· If a company sells more than one product, they are sold in the same mix

Running this analysis involves using several equations for price, cost and other variables, then plotting them out on an economic graph.

Cost-Volume-Profit Analysis Formula Is

The CVP formula can be used to calculate the sales volume needed to cover costs and break even, in the CVP breakeven sales volume formula, as follows:

      

Where FC is Fixed costs and CM is Contribution margin=Sales−Variable Costs

​To use the above formula to find a company's target sales volume, simply add a target profit amount per unit to the fixed-cost component of the formula. This allows you to solve for the target volume based on the assumptions used in the model.

CVP analysis looks primarily at the effects of differing levels of activity on the financial results of a business. The reason for the particular focus on sales volume is because, in the short-run, sales price, and the cost of materials and labour, are usually known with a degree of accuracy. Sales volume, however, is not usually so predictable and therefore, in the short-run, profitability often hinges upon it.

What Does Cost-Volume-Profit Analysis Tell You?

The contribution margin is used in the determination of the break-even point of sales. By dividing the total fixed costs by the contribution margin ratio, the break-even point of sales in terms of total dollars may be calculated. For example, a company with $100,000 of fixed costs and a contribution margin of 40% must earn revenue of $250,000 to break even.

Profit may be added to the fixed costs to perform CVP analysis on a desired outcome. For example, if the previous company desired an accounting profit of $50,000, the total sales revenue is found by dividing $150,000 (the sum of fixed costs and desired profit) by the contribution margin of 40%. This example yields a required sales revenue of $375,000.

CVP analysis is only reliable if costs are fixed within a specified production level. All units produced are assumed to be sold, and all fixed costs must be stable in a CVP analysis. Another assumption is all changes in expenses occur because of changes in activity level. Semi-variable expenses must be split between expense classifications using the high-low method, scatter plot or statistical regression.