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Cost-Volume-Profit Analysis

Table of Contents

**Introduction of Cost-Volume-Profit Analysis**

**Cost volume profit analysis**which is known as break even analysis is an extension of marginal costing. Break even analysis establishes the relationship between cost and profit with sales volume it represent a specific method of presenting and studying the interrelationship between cost volume and. It also helps in determination of that value of sales at which cost and revenues are in equilibrium the equilibrium point is often referred to as the break-even point. The breakeven point may be defined as that point of sales volume at which the total revenue is equal to the total . Briefly it is a no profit no loss point.

**Cost volume profit analysis**is a method of cost accounting that looks at the impact that variety levels of cost and volume have on operating. The cost volume profit analysis also commonly known as break even analysis looks to determine the break even profit for different sales volume and cost structures cost volume profit analysis is used to determine how changes in cost and volume affect the companyβs operating income and net income.

**Cost volume profit analysis**requires that all the company’s cost including manufacturer selling and administrative cost be identified as variable or fixed.

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**Definitions****:-**

βThe study of the effects on future profits of changes in fixed cost and variable cost sales price quantity and mix.β

Thus,

**Cost-Volume-Profit Analysis**is the best model to study the inter-related relationship between cost, price and profit structure of a company. It is a formal profit planning approach based on established relationship between different factors affecting profit. The usual starting point in such an analysis is the determination of the company’s BEP point. Thus, breakeven analysis forms just one component of the total system of cost-volume profit analysis.One of the important steps in cost-volume profit and break-even analysis is that of segregation of costs into fixed and variable costs. If the break-even point is to occur, it becomes essential that the business enterprise has some variable costs and some fixed costs.

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**Assumptions****:-**

1)

**Cost-volume-profit analysis**data are based upon certain ASM conditions which are really found in practice some of the basic assumptions of CVP analysis are given below2) Cost can be classified into their fixed and variable components

3) The principles of cost variability is valid

4) Variable cost very proportionately with the volume changes

5) Fixed cost remain constant irrespective of the level of activity

6) Selling price does not change with the volume changes

7) There is no change in the general price level

8) Productivity per worker remain constant

9) Plant capacity and efficiency remain unaffected

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**Usefulness/Advantages/Merits****:-**

1) It is simple tool employed to graphically represent complicated accounting data

2) It is more useful diagnostic tool

3) It provides basic information facilitating further studies on improving the profit

4) It is also used for analyzing the risk of alternative actions

5) It is useful in marketing strategy also

Limitations

1) The applications of breakeven analysis to multi-product firm becomes very difficult

2) Since the break even analysis is a short run concept it has a limited application in the long range planning

3) The breakeven tool is static tool with very limited practical applications

4) It is very difficult if not impossible to separate cost into fixed and variable components

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**Cost Volume Profit -CVP formulaπ****:-**

**= fixed cost/contribution margin**

*Break even sales volume***= contribution margin/sales**

*Contribution margin ratio*

**CVP analysis**is also used when a company is trying to determine what level of sales is necessary to reach a specific level of income a so-called targeted income

*= fixed cost + targeted income (Targeted Contribution) /contribution margin ratio*

**Require sales in rupees****fixed cost + targeted income (Targeted Contribution) /contribution margin per unit**

*Required sales in unit=* To use of the above formula to find a company’s target sales volume, simply add a target profit amount per unit to be fixed cost component of the formula. This allows you to solve for the target volume based on assumptions used in the model.

The Contribution Margin is used in the determination of the break-even point of sales. By dividing the Total Fixed Costs by the contribution Margin Ratio, the break-even point of sales in terms of total rupees may be calculated.

**CVP Analysis**also manages product ‘Contribution Margin’ is the difference between Total Sales and Total Variable Costs. For a business to be profitable, the Contribution Margin must be exceed Total Fixed Costs. The Contribution Margin may also be calculated by per unit. The unit Contribution Margin is simply the remainder after the unit Variable Cost is subtracted from the unit sales price. The Contribution Margin Ratio is determined by dividing the Contribution Margin by Total Sales.

**CVP Analysis**is most often used to determine a company’s BEP point. This is the level of sales where the company will not incur a loss and profit. To calculate the BEP, you must first calculate the ‘Contribution Margin’.

**CVP Analysis**is also used when a company is trying to determine what level of sales is necessary to reach a specific level of income also called “targeted income”.

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