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CVP ANALYSIS - Coursework Example

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CVP Analysis Date CVP Analysis 1. What are the features of cost-volume profit (CVP) analysis? The features of cost-volume profit (CVP) analysis include the assumption that the sales price per unit, variable costs per unit and total fixed costs are all constant (John Wiley & Sons, Inc., n.d.)…
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CVP Analysis CVP Analysis What are the features of cost-volume profit (CVP) analysis? The features of cost-volume profit (CVP) analysis include the assumption that the sales price per unit, variable costs per unit and total fixed costs are all constant (John Wiley & Sons, Inc., n.d.). Another feature of the CVP is that it assumes that everything produced is sold (John Wiley & Sons, Inc., n.d.). The main feature of the CVP is that it analyzes the relationship among revenue, cost and volume and their effect on profit (Highered.mcgraw-hill.com, n.d.). The profit equation, Operating Profit = Total Revenues – Total Costs is the important relation for CVP analysis (Highered.mcgraw-hill.com, n.d.). To make this equation more useful, CVP analysis divides the costs into the variable and fixed costs. The contribution margin is then determined. The contribution margin is defined as the sales price minus the variable cost. The CVP analysis is important in analyzing the effect of different cost structures in a company. It is essential that organizations understand the cost structures of their business because of its effects on volume and profits. Another key feature of CVP analysis is that the cost structures greatly affect operating and investment decisions. CVP analysis also helps identify products or operations which should be discontinued if their contribution to profit is very minimal only. 2. Why are managers interested in the break-even analysis point? Managers are interested in the break-even analysis point because it is important to determine the volume of sales needed in order to be able to cover both the fixed costs and the variable costs. It is at this point that sales is equal to the fixed costs and variable costs (Accounting for Management, n.d.). The break-even analysis illustrates the relationship between sales and production costs. Its analysis can be extended further and show how changes in prices of goods and fixed and variable costs will affect the profit levels (Gutierrez & Dalsted, 2012). For managers, the break-even point is the “lowest amount of business activity necessary to prevent losses” (Gutierrez & Dalsted, 2012). Managers use the break-even analysis for analyzing capital expenditures (MIRA Consulting, 2007). Break-even is one method of determining if it is advantageous for the firm to carry out a capital expenditure. Another reason why managers are interested in the break-even analysis is because it serves as a guide in deciding the pricing policies that the company will undertake. Prices can either be increased or lowered by considering the break-even point. In the same manner, labor costs are also established with the help of the break-even point. Since a portion of the labor costs may be divided into a fixed cost and a variable cost component, it is a factor considered in the amount of salary to be paid to the workers. Usually, the fixed labor costs are the salaries of the administrative staff while the variable component of labor costs are the direct labor costs, which tend to increase as volume of production increases. With break-even point analysis, managers will be forced to study and understand the cost structure of the company. The analysis will require managers to specifically identify which are fixed and variable costs. Break-even analysis helps a manager decide whether when an investment will generate a positive return (Gutierrez & Dalsted, 2012). Since the break-even point analysis will show the contribution of every unit sold above that point, it will give the manager an idea how much a unit sold will add to the profit. Managers can therefore determine more or less if an investment will be profitable. 3. Compare contribution margin and fixed costs. “Contribution margin is the total revenue minus total variable cost” (John Wiley & Sons, Inc., n.d.). Fixed costs are not included in the contribution margin. The exclusion of fixed costs in the contribution margin gives one a clearer picture of the contribution of a product to the profitability of a firm. Products are better compared if the fixed costs are not included. Fixed costs are costs which are not directly related to the level of production (Gutierrez & Dalsted, 2012). This means that even if a company increases the volume of production, the fixed costs remain unchanged. Examples of fixed costs are depreciation, interest costs, taxes, administrative salaries, insurance, rent and general overhead expenses. The contribution margin per unit covers the fixed cost and gives the operating profit. References Accounting for Management. (n.d.). Break even point analysis-definition, explanation formula and calculation. Retrieved July 30, 2012, from accounting4management.com: http://www.accounting4management.com/Break_even_analysis.htm (n.d.). Chapter 3 - Fundamentals of cost-volume-profit analysis. McGraw Hill. Gutierrez, P., & Dalsted, N. L. (2012, July 2). Break-even method of investment analysis. Retrieved July 30, 2012, from ext.colostate.edu: http://www.ext.colostate.edu/pubs/farmmgt/03759.html John Wiley & Sons, Inc. (n.d.). Cost-volume-profit analysis. Retrieved July 30, 2012, from cliffnotes.com: http://www.cliffsnotes.com/study_guide/Cost-Volume-Profit-Analysis.topicArticleId-21248,articleId-21229.html MIRA Consulting. (2007, September 3). Breakeven Analysis. Retrieved July 30, 2012, from miraconsulting.com : http://www.miraconsulting.com/breakeven_analysis.htm Read More
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