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Cost-Volume-Profit Analysis

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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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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 below

2) 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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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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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.

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