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Assignment
Limitations of cvp analysis.
Cost volume profit analysis.
In any business it is very obvious for questions like, what effect on profit can it expect if it produces more products? What quantity of products and services must a business sell in order to break even for the year? What happens to the breakeven point of the business if it decides to add or increase the quantity of a product or services they currently offer? to arise. The analytical technique that helps the managerial accountants to address these questions is called Cost Volume profit analysis. (Tata McGraw-Hill, 2008 p.298). It provides with vital information about the effect of revenue raised and the cost incurred within a certain business. CVP analysis can also be used to analyse the effect on profit due to changes in prices, costs, tax, interests and the mix of product sold by the organisation. (Tata McGraw-Hill, 2008 p.298). CVP analysis is used by the managers in day to day basis in order to run the business smoothly. Correct use of this can lead to a detailed understanding of what actions should and can be taken in order to save the business from facing any loss, and make profit or at least break even. CVP analysis is a helpful tool for the management but it also suffers with some limitations. It provides the management with the insight of the current position of the business and also reflects any potential problems the company could face in a short run. CVP graph directs management’s attention to this situation but is not able to provide a solution to any potential problem within the business. (Tata McGraw-Hill, 2008 p.303). Many assumptions should be made in order to produce a CVP analysis such as, keeping the total revenue linear which means the price or product or service will not change as sales changes, keeping total expense linear which means the total fixed and the unit variable expense remains unchanged as activity varies, the efficiency and productivity remains...
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...Fitness franchise ownership.
CVP Analysis
CVP analysis considers the relationship among volume or activity level, unit selling prices, variable cost per unit, total fixed costs, and sales mix. When managers know how costs will behave at specific levels of activity, they may prepare more accurate budgets as well as project how profitable products will be, it serves as an aid in making good business decisions. These statements are different from traditional statements in that they classify costs as variable or fixed and compute a contribution margin, the balance of revenue after deducing variable costs. The contribution margin is the amount that is available for fixed costs (Kimmel, etal, 2009).
Break-Even Analysis
A break-even point is the point at which total revenues equal total fixed and variable costs. At this level of activity, the company’s net income is zero. When managers know the break-even point, they are better equipped to price products, both old and new. The break-even point can be computed by using the contribution margin (Kimmel, etal. 2009).
Snap Fitness has 300 members at a cost of $26; that is, $7,800 and the fixed cost is $6,000 ($4,000 plus $2,000 in equipment leases). To break even, the contribution margin has to be $6,000 because at the break-even point, contribution margin must equal total fixed costs. The variable cost is computed as $1,800 ($7,000 minus $6,000). The break-even point is 300 members as a result, the...
...objective of CVP analysis if to establish what will happen to the financial results if a specified level of activity or volume fluctuates. Cost-Volume –Profit Analysis is based on the relationship between volume and sales revenue, costs and profit in the short run, the short run being normally one year, in which the output of a firm is restricted to that available from the current operating capacity.
Profitability Analysis with unit cost drivers
Profitability analysis incorporates examining of the relationship between revenues, cost and profits. It is used in the process of economic evaluation of existing or proposed product or services. Profitability analysis is usually used before decisions are finalized in the operating budget for a future period. Performing such analysis requires an understanding of selling prices and the behavior of activity cost drivers.
Two approaches to profitability analysis are examined in Morse (2005) Cost-Volume-Profit Analysis and Planning:
A unit level approach based on the assumption that units sold or sales dollars is the only activity cost driver
A cost hierarchy approach that incorporates non unit and unit level activity cost drivers
The traditional approach to profitability analysis, considers only unit level activity cost drivers and is identified as cost-volume-profit analysis(CVP).It examines the relationship among the total volume of an independent variable, total cost, total revenues and profits...
...safety, target selling price and sales volume.
* Construct breakeven, contribution and profit volume graph.
* Apply cost volume profit analysis in a multi product setting
* Identify and explain the assumptions and limitations of cost volume profit analysis.
INTRODUCTION
CVP Analysis is a method of examining the relationship between changes in activity (i.e. output) and changes in total sales revenue, expenses and net profit. It is used as a tool for decision making. CIMA’s Official Terminology defined CVP analysis as “the study of the effects on the future profit of changes in fixed cost, variable cost, sales price, quantity and mix”.
A break-even analysis is a more commonly used term but it is often mislead as being synonym to the cost volume profit analysis. In fact, cost volume profit analysis provides much greater significance than break-even analysis.
DIFFERENCES BETWEEN CVP AND BREAKEVEN ANALYSIS
BREAKEVEN ANALYSIS
* To calculate break-even point.
* BEP: the point where total revenues equal total costs.
* At this point, the revenues would have covered all fixed costs and variable costs incurred.
* This point represents the minimum sales volume that should be achieved by organization to avoid losses.
CVP ANALYSIS
* Assists the management in planning and decision making.
* It will be used to answer various questions such as:
* How many...
...a). Name five assumptions that underline the use of break – even analysis.
It is essential that anyone preparing or interpreting CVP information is aware of the underlying assumptions on which the information has been prepared. If these assumptions are not recognized, serious errors may result and incorrect conclusions may be drawn from the analysis.(Drury, 2004).
Breakeven analysis (cost-volume-profit analysis) is an approach to profit planning that requires derivation of various relationships among revenue, fixed costs, and variable costs in order to determine units of production or volume of sales at which firm “breaks even” (where total revenues equal total of fixed and variable costs). The analysis is built on various assumptions.
Below is a brief explanation of five assumptions underlying the use of break-even analysis or the CVP analysis.
1. All other variables remain constant.
It is assumed that all variables other than the particular one under consideration remain constant throughout the analysis. In other words, it is assumed that volume is the only factor that will cause costs and revenues to change. However, changes in other variables such as production efficiency, sales mix, price levels and production methods can have an important influence on sales revenue and costs. If significant changes in these other variables occur the CVP analysis presentation is incorrect.(Drury, 2004). Changes in the levels of revenues...
...a vital factor to a company. It is very important to profit planning. Cost-volume-profit (CVP) analysis is the study of the effects of changes in cost and volume on a company’s profits. It is also a factor in management decisions such as setting selling prices, determining product mix, and maximizing use of production facilities. There are five components that make up a CVP analysis. They are volume or level of activity, unit selling prices, variable cost per unit, total fixed costs, and sales mix. The CVP analysis considers the relationships that each of these components have with each other. A better understanding of what these components are will help set the basis of understanding how the CVP analysis works.
The volume or the level of activity is the current condition of the market and the company. It is a snapshot of what the sales look like. It tells if products are moving or if the business is dead in the water. Unit selling prices are the current selling prices of the products at that point of time. The variable costs per unit are the costs that vary in total directly and proportionately with changes in the activity level. The total fixed costs are the totals of the costs that remain the same in total regardless of changes in the activity level. The sales mix is the percentage that each product represents is total sales. An example of how all of these contribute to the CVP analysis will...
...between cost volume and profit is shown by cost-volume-profit analysis. it is an analytical tool for analyzing the relationship among cost, price, profit, sales and production volume. Mainly there are three element in cost-volume-profit analysis.
It is highly essential for the management to have the complete knowledge about the inter relationship among the cost, volume and profit. for this purpose cost-volume-profit analysis can be regarded as a sophisticated method or analytical tool used in management.
A. Introduction:
Cost-volume-profit (CVP) analysis is one of the most powerful tools that managers at their command. It helps them understand the interrelationship between cost, volume, and profit in an organization by focusing on interaction among the following five elements;
1. prices of products
2. volume or level of activity
3. per unit variable costs
4. total fixed costs
5. mix of products sold
Because CVP analysis helps managers understand the interrelationships among cost, volume, and profit, it is vital tool in many business decisions. These decisions include, for example;
a. what products to manufacture or sell
b. what pricing policy to follow
c. what marketing strategy to employ, and
d. what type of productive facilities to acquire
B. Marginal and absorption costing: different rationales.
Absorption costing stems from the view that certain necessarily incurred to allow output to occur and...
...Management has received a special order. How will profitability be impacted if the order is accepted? |
CVP – Breakeven Analysis If a company expects a drop in raw material price but all other revenue and cost factors to be unaffected, what will be the revised break-even point in sales and units? |
CVP – Breakeven Analysis If a company expects a drop in raw material price but all other revenue and cost factors to be unaffected, what will be the revised break-even point in sales and units? |
Cvp Tools – Break Even Analysis
A
Determine Selling Price/unit
A
Determine Selling Price/unit
Scenario
1. To determine Sales required to cover operating expenses
2. What volume of sales required for desired profit
3. Break even where total costs are covered by total revenue.
Scenario
4. To determine Sales required to cover operating expenses
5. What volume of sales required for desired profit
6. Break even where total costs are covered by total revenue.
B
Determine Variable Costs/unit
B
Determine Variable Costs/unit
C
Calculate Contribution Margin
(A – B)
C
Calculate Contribution Margin
(A – B)
E
Calculate Break Even
(Fixed Costs + Desired Operating Income / CM/unit)
E
Calculate Break Even
(Fixed Costs + Desired Operating Income / CM/unit)
D
Determine Fixed Costs
D
Determine Fixed Costs
Cvp Tools – Contribution Margin...