Question

1. What do you understand by the term Cost-Volume-Profit Relationship.
2. What is Contribution Margin (CM Ratio)? Discuss its importance in profit planning.
3. Discuss the term, Break-even analysis and Margin of Safety.
4. Analyze the usefulness of Operating Leverage in manufacturing organizations.

Answer 1

What do you understand by the term Cost-Volume-Profit Relationship?

Cost volume profit relationship is an analytical tool for studying the relationship between cost, volume and profit. It is a tool for profit planning and analysis of profit. It helps in forecasting profits , formulation of flexible budget , evaluation of performance.

What is Contribution Margin (CM Ratio)? Discuss its importance in profit planning.

Contribution margin ratio is the contribution divided by the sales per unit. It measures the contribution generated by each unit sold. It helps in determining the break even point i.e. the minimum sales to cover fixed costs of the business. It assists in setting the desired level of sales to achieve the desired profit. It helps in a what if analysis and deciding the most profitable level of production and sales.

Discuss the term, Break-even analysis and Margin of Safety.

Break even analysis is the point at which the fixed costs equal the contribution i.e. a point at which there is no profit no loss. Margin of safety is the excess of sales over the break even sales. It is the difference between actual sales and break even sales. A larger margin of safety the good it is for the business.

Analyze the usefulness of Operating Leverage in manufacturing organizations.

Operating leverage is the ratio of EBIT to contribution i.e. the revenues generated by the business to cover fixed costs. A high operating leverage indicates that the company is able to additional revenue without increasing costs. A firm with fixed costs will see an increase in EBIT if the unit sales are rising.