Question

How do hotels use cost-volume-profit analysis?

How does the business benefit from using cost-volume-profit?

Does it have a low or high degree of operating leverage?

Answer 1

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 commonly 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.

The cost-volume-profit analysis makes several assumptions, including that the sales price, fixed costs, and variable cost per unit are constant. Running this analysis involves using several equations for price, cost and other variables, then plotting them out on an economic graph.

The main components of CVP analysis are:

1. CM ratio and variable expense ratio
2. Break-even point (in units or dollars)
3. Margin of safety
4. Changes in net income
5. Degree of operating leverage

Putting all the pieces together and conducting the CVP analysis, companies can then make decisions on whether to invest in certain technologies that will alter their cost structures, and determine the effects on sales and profitability much quicker.

CVP IN HOSPITALITY INDUSTRY

Hospitality industry is one of the most growing sectors globally. Tourism is a very important part in the hospitality industry which is deeply rooted in the society as is important for the development of a country. Due to global recession the tourism industry has given a good push to prosper in many countries.

The method used for the prediction of costs in this industry is the CVP analysis which helps us to predict the costs for various resources required in the coming years to fulfil the demand of the customers. The method used is the direct costing method which is used to separate the fixed and the variable costs from the total costs. They are charging only the variable costs depending on the product whether they are direct or indirect. Costing methods gives a relevant information to the management team so that they take business decisions for the next period. This method gives the basis for cost estimates to study the effect of planned changes on the production volume due to economic conditions or regulate the prices or to increase or decrease the stock according to the requirement.

Answer (2)

Cost-volume-profit analysis looks at different levels of volumes and costs on operating profit. Among the tools in a business manager's decision-making arsenal, CVP analysis provides one of the more detailed and objective ways by which a manager can assess and even predict the course of business for the company and its employees. It makes several assumptions to be relevant, however, which means it will only ever be an approximate calculation.

Advantages are:-

Aids Decision Making, Provide detailed perspectives, Ease of calculation, understandability, Accuracy etc.

Aids Decision-Making

CVP analysis provides managers with the advantage of being able to answer specific pragmatic questions needed in business analysis. Questions such as what the company's breakeven point is help managers project how future spending and production will contribute to the success or failure of the company. For instance, when a manager knows the breakeven point, he can tweak spending and increase production efforts to increase profitability. Because CVP analysis is based on statistical models, decisions can be broken down into probabilities that help with the decision-making process.

Detailed Perspectives

Another major benefit of CVP analysis is that it provides a detailed snapshot of company activity. This includes everything from the costs needed to produce a product to the amount of the product produced. This helps managers determine, very specifically, what the future will hold if variables are altered. For instance, transportation expenses and costs for materials can change. These variable costs can affect the bottom line.

Ease of Calculation

One the biggest advantages to CVP analysis is that calculations are incredibly simple. CVP analysis uses a standard set of formulas that work for all of the analysis techniques. Anyone who can plug numbers into the formulas is able to quickly determine the effects of hypothetical changes in these variables. This makes CVP analysis a useful technique for small-business owners who are new to business or do not have a strong accounting background.

Understandability

For the most part, CVP analysis is free of accounting jargon and complex terminology. This makes both the preparation and interpretation of CVP analysis figures understandable. For example, you might want to know how many individual units of your company's product you would need to sell to break even for the year. In order to make this calculation, you will need to know how much it costs to make your product and how the cost behaves -- that is, whether the cost increases as production increases or whether it is a constant. Unlike some accounting terminology, these cost concepts are intuitive to many small-business owners.

Accuracy

One of the downfalls of CVP analysis is that it isn't always accurate. CVP analysis techniques assume that all costs in the company are completely fixed or completely variable. Fixed costs are costs that do not change with changes in production, such as rent or insurance costs. Variable costs change at a constant rate as you increase the number of units produced. Common variable costs include materials and labor costs. However, there are many costs that have a fixed and variable component, known as mixed costs. For example, you may pay a monthly charge for telephone service, but then pay a change per minute of use. The monthly charge is a fixed cost, but the per-minute charge is variable. CVP analysis does not have a way to deal with these costs unless they are split into their fixed and variable components, which can be cumbersome.

Answer (3)

Operating leverage is a cost-accounting formula that measures the degree to which a firm or project can increase operating income by increasing revenue. A business that generates sales with a high gross margin and low variable costs has high operating leverage.

The higher the degree of operating leverage, the greater the potential danger from forecasting risk, in which a relatively small error in forecasting sales can be magnified into large errors in cash flow projections.

The Formula for Operating Leverage Is

Degree of operating leverage = Contribution margin/Profit

Degree of operating leverage=Q∗CM/ (Q∗CM−Fixed operating costs)

where:Q=unit quantityCM=contribution margin (price - variable cost per unit)