Question

A CVP analysis focuses on sales profit, variables and fixed costs to make assumptions based on the break-even point and support the managers in a short-run decision. In my previous job, I worked in the purchasing department, we had to consider the sales volume, to negotiate volume and variables costs such as exchange rates to evaluate what our saving would be against the raw materials and producing internally.

Did you use CVP analysis at your company? If so, how well did it work? If not, do you think it'd be useful?

Answer 1

Cost-volume-profit analysis, or CVP, is something companies use to figure out how changes in costs and volume affect their operating expenses and net income. CVP works by comparing different relationships, such as the cost of operating and producing goods, the number of goods sold, and profits generated from the sale of those goods. By breaking down costs into fixed versus variable, CVP analysis gives companies strong insight into the profitability of their products or services.

Uses of CVP analysis
Many companies and accounting professionals use cost-volume-profit analysis to make informed decisions about the products or services they sell. In this regard, CVP analysis plays a larger role in managerial accounting than in financing accounting. Managerial accounting focuses on helping managers -- or those tasked with running businesses -- make smart, cost-effective moves. Financial accounting, by contrast, focuses more on painting an economic picture of a company so that outside parties, such as banks or investors, can determine how financially healthy it is.

Elements of CVP analysis
The three elements involved in CVP analysis are:

1. Cost, which means the expenses involved in producing or selling a product or service.
2. Volume, which means the number of units produced in the case of a physical product, or the amount of service sold.
3. Profit, which means the difference between the selling price of a product or service minus the cost to produce or provide it.

Assumptions when using CVP analysis
When managers use CVP analysis to make business decisions, the following assumptions are made:

• All costs, including manufacturing, administrative, and overhead costs, can be accurately identified as either fixed or variable.
• The selling price per unit is constant.
• Changes in activity are the only factors that affect costs.
• All units produced are sold.

Contribution margin
CVP analysis can help companies determine their contribution margin, which is the amount remaining from sales revenue after all variable expenses have been deducted. The amount that remains is first used to cover fixed costs, and whatever remains afterward is considered profit.

If a company has $500,000 in sales revenue with variable costs totaling $300,000, then its contribution margin is $200,000. If that company sells 50,000 units in a given year, then the sales price per unit is $10 and the total variable cost per unit is $6, leaving a contribution margin of $4 per unit. The contribution margin can help companies determine whether they need to reduce their variable costs for a given product or increase the price per unit to be more profitable

YES, I WILL USE CVC ANALYSIS AT MY COMPANY. IT WORK AS BELOW.

CVP Analysis Steps:-

1. Classify costs & identify contribution margin.
2. Calculate break-even point in units & dollars.
3. The margin of safety & Target income calculations.
4. Using CVP analysis model for Sensitivity Analysis.

Classify costs & identify contribution margin:-

CVP analysis classifies all costs as either fixed or variable. Fixed costs are expenses that don’t fluctuate directly with the volume of units produced/sold. An example of a fixed cost is rent expense for a retail store. It doesn’t matter how many units will be sold in the store. The rent expense will always be the same.

On the other hand, Variable costs change with the levels of production/sales. These costs include materials and labor that go into each unit produced. For example, the cost of PCs sold in a retail store is considered as the variable cost; the more units sold, the more PCs cost will be.

Contribution Margin: unit contribution margin is the selling price of a product minus all variable costs incurred to produce or sell this product. It measures the amount of the selling price of a unit that is used to cover fixed costs for this unit.

• Unit Contribution Margin (UCM) = unit selling price - unit variable cost.
• Contribution margin % = UCM / Unit selling price.

Calculate break-even point in units & dollars:-

Simply; the break-even point is the sales level where total revenues equal total costs. But the main thing that you must understand in break-even analysis is the difference between revenues and profits. Not all revenues result in profits for the company. Many products cost more to make or sell than the revenues they generate. Since the expenses are greater than the revenues, these products great a loss not a profit.

The purpose of the break-even analysis is to calculate the amount of sales that equates revenues to expenses and the amount of excess revenues, also known as profits after the variable & fixed costs are met.

• Break-even point in units = Total Fixed Cost / Unit contribution margin (UCM).
• Break-even point in dollars = Fixed Costs / Contribution margin %.

The margin of safety & Target income calculations:-

The margin of safety is the excess of budgeted sales over break-even sales. It's the amount by which sales can decline before losses occur.

The margin of safety = Planned Sales - Break-even sales*

Margin of safety % = Margin of safety / Planned sales

*Break-even sales means the sales amount that achieves the break-even point.

Target Income Calculations:-

Target income sales can be measured in CVP analysis based on Target Operating Income or Target Net Income (the variance mainly depend on that tax rate in each country). Let's focus here on Target Operating Income.

Target Income Sales is the number of sales needed to cover all variable & fixed costs plus the target income. Target income is the operating income which a company wants to achieve during a specific period.

Target Income sales in units = (Fixed Costs + Target operating income) / UCM

Target Income sales in $ = (Fixed Costs + Target operating income) / contribution margin %.

Using CVP analysis model for Sensitivity Analysis:-

CVP analysis model can be used for a single product, multiple products & service companies as well to perform sensitivity analysis (also called what-if analysis).

Sensitivity analysis shows how the CVP model will change with changes in any of its variables (fixed costs, variable costs, sales price, or sales mix). The focus is typically on how changes in variables will affect profit.

Finally, sensitivity analysis can be used in break-even & target income sales calculations because it offers different scenarios whether by increasing sales, reducing variable cost or even cutting down fixed cost. FP&A professionals rely on Microsoft Excel so much to perform CVP & sensitivity analysis models

CVP ANALYSIS IS USEFUL WHICH DESCRIBE AS BELOW:

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 helps 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. CVP analysis allows the manager to plug in variable costs to establish an idea of future performance, within a range of possibilities. This, however, can be a disadvantage to managers who are not detail-oriented and precise with the data they record. Projections based on cost estimates, rather than precise numbers, can result in inaccurate projections.