Question

In your opinion, how analyzing cost behaviour is useful?

Discuss why contribution margin and break-even can be used by managers?

Answer the two questions using graphs in your analysis.

Answer 1

Cost behaviour analysis helps the mangement of an organisation to understand how the change in activity will impact the earnings. Costs can be broadly divided into variable costs and fixed costs. Variable costs are directly attributable to production and increase with change in production. for eg: Direct labour, material. Fixed costs are fixed irrespective of the production. For eg: Rent, Admin exp.

Thus cost analysis will help the company in identifying its costs and the factors affecting them.

Contribution margin = Sales - Variable costs. The contribution margin tells us the amount of contribution received from each unit of sale. It helps in recovering the fixed costs of the organisation

Break even point = Fixed costs / Contribution margin per unit. The break even point tells us the qty or value of sales at which the company will cover all its fixed costs. In other words, the company will be at no profit no loss. Additional sales above break even point will lead to profits in the organisation.

As we can see in the above graph as the contribution margin increases the fixed costs will be covered by the organisation. The break even point is at 250 when all the fixed costs are covered by contribution margin.