Question

What are the biggest challenges for managers using cvp analysis to make product decisions? Why?

Answer 1

In spite of CVP being a useful technique, it suffers from some of the following challenges for the managers :

1. Because of the many assumptions, CVP is only an approximation at best. CVP analysis needs estimates and approximation in assembling necessary data and thus lacks accuracy and precision.

2. In CVP analysis, it is assumed that total sales and total costs are linear and can be represented by straight lines. In some cases, this assumption may not be found true. For instance, if a business firm sells more units, the variable costs per unit may decrease due to more operating efficiencies in the factory.

3. CVP analysis is performed within a relevant range of operating activity and it is assumed that productivity and efficiency of operations will remain constant. This assumption may not be valid.

4. CVP analysis assumes that costs can be accurately divided into fixed and variable categories. Such categorization is sometimes difficult in practice.

5. CVP analysis assumes no change in the inventory quantities, during the period. That is, opening inventory units equal the closing inventory units. This also means that units produced dur­ing the period are equal to units sold. When changes take place in inventory level, CVP analysis becomes more complex.

6. If prices, unit costs, sales-mix, operating efficiency, or other relevant factors change, then the overall CVP analysis and relationships also must be modified. Because of these assumptions, cost data are of limited significance.

7. Furthermore, a number of problems arise while making a multi-product analysis under CVP analysis. The first problem is identifying the facilities which are shared by unrelated products. If fixed expenses and facility usages can be identified directly with individual products, the analysis will be satisfactory. A second problem occurs if there is a non-linear relationship in the units of measurement. Different products typically yield different contribution margins and are produced in various volumes with differing costs.

As a result neither the revenue curve nor the cost curve is necessarily straight and the break-even point is difficult to find. A third problem lies in the assumption of certainty in demand projections. Most analyses performed by accountants and managers are deterministic, certainty is assumed although uncertainty is the environment of operation.

A fourth problem is the complexity of analysis where several products are concerned. The maker of revenue and cost curves for each product plotted on the conventional break-even group results generally in a meaningless hodgepodge.

Therefore, while preparing or interpreting cost-volume profit analysis all assumptions and limita­tions should be carefully considered. A series of CVP analysis, based on different sets of assumptions and circumstances may be prepared to reflect situations prevailing in different business enterprises. When circumstances change, CVP analysis should also be revised to reflect the changing situations. It is also necessary to have up-to-date analysis so that it can act as a useful device in profit forecast, budgeting, cost control and managerial decision-making.