Question. 3)What is CVP analysis? How
does it differ from break-even analysis?
CPV analysis is a system used for
checking how changes in the volume of production affect the costs and thus the
profits. It is an expanded form of break-even analysis, which simply
identifies the breakeven point. CVP analysis is somewhat
simplified and relies on some assumptions that do not hold in reality, meaning
it is best used for simple "big picture" analysis rather
than detailed examination.
Breakeven analysis takes account of
the fact that production incurs both fixed and variable costs. Fixed costs
include machinery, factory real estate and, to some extent,
marketing. Variable costs include labor and raw materials; more of these
resources are used as more products are made. The break-even point is calculated
as the fixed costs divided by the contribution per unit. The contribution per
unit is the price the company sells the product at, minus the specific variable
costs associated with producing that individual unit.
CVP analysis takes its name from
cost, volume and profit. The associated analysis plots two lines on a
graph with a horizontal axis that shows the total number of units produced. The
two lines represent the total revenue and the total cost for that number of
units. In virtually every case, the revenue line will start out higher than the
cost line, but go up at a steeper angle and eventually narrow the gap before
overtaking the cost line and then widening its lead. This represents increasing
sales lowering losses, hitting the breakeven point and then producing
increasing profits.
There are several significant limitations to
these figures which result from simplified assumptions in the process. One
obvious one is that it assumes that every unit produced will automatically be
sold. This is often not the case in reality, and the more units that are
produced, the greater the risk of being left with unsold stock.
Another problem
with CVP analysis is that in reality there is some crossover
between fixed and variable costs. For example, the fixed cost of machinery will
increase once it is running at full capacity and production is then increased.
Meanwhile variable costs don't always vary perfectly in line with the volume of
production. A business may be able to increase production without increasing labor
costs to the same extent if it is able to pick up some slack in the staff's
workload.
CVP analysis also has the
limitation that it fails to account for all the ways figures may vary. The
sales price is treated as a constant, but in the real world, increased sales
may entail some buyers getting a bulk discount. Similarly, the variable cost
per unit may not be consistent, for example, if materials can be bought in
large quantities at a lower price.
- Definition
Cost Volume Profit Analysis (CVP Analysis) is one of the most powerful
tools that managers have at their command. It helps them to understand the
relationship between cost, volume, and profit in an organization by
focusing on interactions among the different elements.
- 3.
These five elements are:- Price of products Volume or Level of activity
Per unit variable cost Total fixed cost Mix of product sold
- 4.
CVP Analysis help managers to take various decisions regarding business
i.e : What product to manufacture or sell What pricing policy to follow
What marketing strategy to employ What type of productive facilities to
acquire
- 5.
Components of CVP Analysis are:- Level or volume of activity Unit selling
prices Variable cost per unit Total fixed cost Sales Mix
- 6.
Assumptions CVP assumes the following: Constant sales price; Constant
variable cost per unit; Constant total fixed cost; Constant sales mix;
Units sold equal units produced.
- 7.
Limitations CVP is a short run, marginal analysis It assumes that unit
variable costs and unit revenues are constant, which is appropriate for
small deviations from current production and sales. Assumes a neat
division between fixed costs and variable costs, though in the long run
all costs are variable. For longer-term analysis that considers the entire
life-cycle of a product, one therefore often prefers activity-based
costing or throughput accounting.
- 8.
The following formula’s are used to solve profit/volume ratio:- P/V Ratio=
Contribution/Sales or, P/V Ratio = Fixed Cost + Profit/Sales or, P/V Ratio
= Change in Profit or Contribution/ Change in Sales
- 9.
Example Sales Rs. 1,00,000 Profit Rs. 10,000 Variable cost 70% Find out
(i) P/V Ratio, (ii) Fixed Cost, (iii) Sales volume to earn a profit of Rs.
40,000
- 10.
Break Even Point The break even point (BEP) is the point at which cost or
expenses and revenue are equal: there is no net loss or gain, and one has
“broken even”. A profit or a loss has not been made, although opportunity
costs have been paid, and capital has received the risk-adjusted.
- 11.
Methods of computing BEP Equation Approach Contribution approach Graphical
Approach
- 12.
Applications The break even point is one of the simplest yet least used
analytical tools in management. It helps to provide a dynamic view of the
relationships, between sales, cost and profit.
- 13.
Limitations Break Even analysis is only a supply side (i.e costs only)
analysis, as it tells you nothing about what sales are actually likely to
be for the product at these various prices. It assumes that fixed cost
(FC) are constant .Although this is true in short run, an increase in the
scale of production is likely to cause fixed cost to rise. In
multi-product companies. It assumes that the relative proportions of each
product sold and produced are constant (ie.,the sales mix is constant).
- 14.
The following formulae’s are used to calculate Break Even Point:- Break
Even Point (as % of capacity) = Fixed Cost/Total Contribution Break Even
Point (in units)= Fixed Cost/Selling Price Per Unit-Variable Cost Break
Even Point (in sales value)=Fixed Cost* Sales/Sales-Variable Cost
- 15.
Example From the following information, calculate the break even point in
units and in sales value: Output = 3,000 units Selling price per unit =
Rs.30 Variable Cost Per unit = Rs.20 Total Fixed Cost = Rs.20,000
- 16.
Applications of Marginal Costing Managerial Decision Relating to
Determination of Optimum Selling Price
- 17.
To check the Effect of Reducing of Current Price on profit
18. Choose of Good Product Mix Calculation of
Margin of Safety Decision Regarding to Sell goods at Different Prices to
Different Customers
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