Generally, profit is not just happened; profits are managed.
The main objective of the business firm or company is to earn maximum profit.
Profit is depended on following factors:
Cost of production
Volume of production
Control of variable cost and fixed cost
Selling price etc
Cost volume profit analysis is the proper tool of profit planning, cost control, budgeting etc.
From this tool, manufacturing company analyses about level of production and trading company analyses volume of sales.
The total cost of a firm depends on the fixed cost, variable costs and volume of output.
Fixed cost remains fixed at all levels of production in the short-run.
Variable cost proportionately changes with the volume of output.
So, there is a direct relationship between the cost of production, the volume of output, and profit earned.
All these factors are interdependent.
Sales = Fixed cost + Variable cost + Profit – Loss
Sales, variable cost, fixed cost, profit or loss
Cost-volume-profit (CVP) analysis is a way to find out how changes in variable and fixed costs affect a firm’s profit.
Companies can use CVP to see how many units they need to sell to break even (cover all costs) or reach a certain minimum profit margin.
CVP analysis makes several assumptions, including that the sales price, fixed and variable cost per unit are constant.
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The cost volume profit analysis (CVPA) is also known as breakeven analysis.
CVPA determines the breakeven point for different sales volumes and cost structures.
It can be useful for managers for making short-term business decisions.
CVPA makes several assumptions; sales price, fixed cost and variable cost per unit are constant in CVPA.
CVPA also manages contribution margin.
The contribution margin is the difference between total sales and total variable costs.
The main motive of the business is to earn the profits.
For profit, the contribution margin must be exceed to total fixed costs.
The contribution margin may also be calculated per unit.
Keep In Mind (KIM)
If possible, first try to find out contribution or profit volume ratio (P/V Ratio).
If there is any revised (increased or decreased) value like SSPU, VCPU, Fixed Cost, P/V Ratio etc.
They will be written as revised value.
While applying cost volume profit analysis, following assumption should be considered:
Selling prices are constant at all the sales volume.
Materials price and wage rate are constant at all sales volume
Fixed cost and variable cost can be established with reasonable accuracy.
On all output level, fixed cost remains static and marginal cost variable at all the level of output.
The production volume is equal to sales volume viz no opening stock and closing stock.
Turnover or sales volume is the only relevant factor affecting cost and revenue.
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The main purposes of cost volume profit analysis are as follows:
To calculate the sales volume and breakeven point in rupees as well as units
To find out effect of changing on price, cost and profit
To find out new breakeven point if cost and selling price are changed
To determine required sales for desired profit
To select the most profitable alternative
To take decision about produce or buy etc
The CVPA enables the management for planning and policymaking decisions more intelligently.
Specific uses and application of cost-volume-profit analysis are given below:
Sales and pricing policies,
Determination of profit from any given volume of sales,
Analysis of the effect of changes in selling price,
Effect of changes in the product mixture,
Additional sales volume needed to support additional expenditure,
The lowest price at which business contributes something towards net profit,
The particular products to be emphasized to reflect the highest net profit,
Financial and production problems,
Determination of unit costs at various volume levels,
Determination of the probable effect of investment in new plant and equipment,
Determination of the most profitable use of scarce materials,
Assistance in the choice between the make or buys decisions etc.
The major limitations of cost volume profit analysis are as follows:
There are problems in identifying fixed and variable costs.
Fixed costs are not always fixed.
Proportionate relation between variable cost and volume of output are not always effective.
Selling price per unit is not always constant.
It is not suitable for a multiproduct firm.
It ignores the influence of other factors on cost and profit.
It is not effective in the long run.
There is more emphasis on sales.
It is a statistic tool.
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