Question

Cost-volume-profit (CVP) analysis is a powerful tool for planning and decision making. Thus, CVP analysis emphasized the interrelationships of costs, quantity sold, and price. This analysis is defined as assessment of total revenues, total costs and operating income in response to changes in the volume of sales, the selling price, variable cost or fixed costs of production. The CVP analysis can be a valuable tool in identifying the extent and magnitude of the economic trouble a company is facing and helping pinpoint the necessary solution. Breakeven is a critical concept to CVP analysis.

The break-even point is the level of activity where total revenue equals total cost. Knowledge of the break-even point is useful management information as it is beyond this point that profit will be earned. The breakeven point tells managers that how much they must sell to avoid a loss. However, the application of break-even analysis is come with limitations.

Required:

With reference to journal articles, you are asked to discuss the limitations of break-even analysis in production and how to overcome these limitations.

Answer 1

LIMITATIONS OF BREAK-EVEN ANALYSIS

· Unrealistic assumptions: products are not sold at the same price at different levels of output; fixed costs do vary when output changes

· Sales are unlikely to be the same as output: there may be some build-up of stocks or wasted output too

· Variable costs do not always stay the same. It means, as output rises, the business may benefit from being able to buy inputs at lower prices (buying power), which would reduce variable cost per unit.

· Most businesses sell more than one product, so break-even for the business becomes harder to calculate

· Break-even analysis should be seen as a planning aid rather than a decision-making tool

HOW TO OVERCOME IT

· Use as a supporting tool: Break even analysis use as a supporting tool and not fully depend on it

· Use on normal business conditions only: That means not use the values in decreasing market situations and seasons of product. At this time we cannot predict it

· Made product wise calculations: Some businesses are selling more than one products so these kind of businesses calculate product wise break even analysis.