Cost Volume Profit Analysis

Cost Volume Profit Analysis
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Features of cost volume profit analysis
Cost-volume-profit analysis better known by its initials CVP, is a simple model used in managers to establish how price, costs, and volumes of sale impact on the profits of the business entity. The change on profits may be as a result of a single or a combination of the parameters that are mentioned above. Based on the information got from this analysis, the manager of the business entity can be able to determine a wide range of issues like the type of services or goods to focus on more, the quantity of sale that is needed to get the expected profit, how much should be budgeted for open costs and the amount of sales required to reduce losses (Foster, 2008).
The cost-volume-profit analysis has the following major features:
Total fixed costs
Selling price per unit
The activity level
The per unit variable costs
In coming up with cost-volume-profit analysis a number of assumptions are made. Among them are:
The number/volume of goods sold is the same as the number/volume of goods produced. This in other words means that the inventory of ending finished goods is not there or does not undergo any changes. This is often not true but if it is assumed then there is likely to be a disconnect between the net income (operating) from financial accounting and the profits obtained from the contribution method.
In the activity range considered the revenue and costs behavior in a linear manner.
All the costs that the business incurs are either variable or fixed and are linear- The assumption here is that fixed costs, for instance, will always remain fixed. This however not the case especially if there is a sharp fluctuation of volume.
The costs incurred by the business are only determined by variations in activity
The ratio of a product to the total volume of sales (sales mix) does not change when the business entity sells different product types. This assumption is particularly insignificant if there is uniformity in the unit contribution margins. If however these unit contributions margins lack uniformity there is likely to be a significant effect on the total ration of contribution margin. This is likely to have a major impact on the information obtained from the cost-volume-profit analysis. A better way of going about this is to carry out CVP analysis based on the contribution margins of individual products. This however requires that the management be able to predict changes in the sales mix.
There is a constant selling price- This assumes that changes in the unit volume are going to have no impact on the product’s selling price. This is untru...