Question

Find a numerical example of cost-volume-profit (CVP) analysis, and analyze how CVP analysis is used for decision making?

Answer 1

Numerical example of CVP analysis is as follows:

Selling price =$ 20

Projected Estimated Demand=1,00,000 units

Variable cost=$ 16

Fixed Cost =$200,000

The above data based on the CVP Analysis can be used to find out trhe following:

1. Break Even point in units: Selling price per unit=$20

                                        Variable cost per unit $16

                                          Contribution per unit $ 4

Fixed cost =$2,00,000

Break-Even point in units=$ 2,00,000/$4= 50,000 units

b. Volume of revenue required if sales price increases to $26 and target profit =$20000

Contribution per unit=$26-$16=$10

Required sales volume=$220000/$10=22000 units

Required sales revenue=22000 units*$26=$ 572000

A CVP analysis is a way of measuring the changes to the financial health of the organization as it relates to the sales. It depicts clearly how the changes in the sales volume , sales prices and the costs would affect the profits.

CVP analysis helps in decision making in the following ways:

1. CVP analysis that is based on the sensitivity analysis aids the managers in giving solutions to the following questions in order to cope with the situations of uncertainity:

1. What would be the profit if the sales mix changes from the originally decided sales mix
2. What would be the                 profit if the fixed cost change
3. What would be the                 profit if the variable cost change

2. CVP analysis helps in understanding how many units of sales output would be targeted so that it can cover all its expenses and break- even.
3. CVP analysis helps in various areas like solving the problems in the areas of profit planning, product planning, make or buy decision, whether to expand or contract a product line, utilization of productive capacity in a period of economic boom or depression
4. Cost-volume-profit analysis can be used in area of budgetary control in order to facilitate the comparison of the budgeted sales, volume, cost and profit with actual. The analysis of the variance is being calculated only for cost-volume-profit. The process of comparing actual result with planned results and reporting within the control framework helps expenditure to be kept within the pre-decided limits. Deviations are also noted so that corrective action can be taken .
5. Pricing decision are those strategic decision that have an effect on the quality of the product produced and sold, and therefore the cost and revenues. To make these decisions possible the managers need to understand cost behavior patterns and cost drivers so that they can then evaluate the value chain and over a products life cycle in order to achieve the profitability