Question

Using the Internet, review at least 3 articles on Profit-Cost-Volume relationship. Summary (the articles in your own words.

As a manager, why is Profit-cost-volume important in planning? Support your response with numerical example(s)

in 200 words

Answer 1

Cost-volume-profit ( C-V-P) analysis is the most fundamental tool because it provides straightforward ways to study the effects of changes in costs and volume on a company’s profits. C-V-P analysis is important in profit planning. In C-V-P analysis executives and accountants recognize that there are many interacting variables that affect an organization’s profits-such things as the sales price of a product, the variable costs per unit, and the volume of production and sales. C-V-P analysis evaluates the relationships among these interacting variables and the effect that changes in these variables have on an organization’s profits. As the term itself suggests, C-V-P analysis is an analytical technique which examines costs and revenue behavioral patterns and their relationships with profit. The analysis separates costs into fixed and variable components and determines the levels of activity where costs and revenues are in equilibrium. We define C-V-P analysis as a mature model in such management decisions as setting selling prices, determining cost, determining the best product mix, and making maximum use of production facilities. The usual starting point in such an analysis is the determination of the company’s break – even point. Thus, break – even analysis forms often a key component of the total system of C-V-P analysis which gives the executives and accountants many insights in profit planning.
C-V-P reasonably accurate forecast of future profits; Assess the degree of risk involved in output fluctuation. If the present activity level of the organization is very near to no profit no loss situation or the proportion of fixed cost in the cost structure is very high, the degree of risk will be high in as much as a slight fall in output will lead to a significant fall in profit. This is also known as operating risk.

Importance of CVP

Management, uses CVP analysis to predict and evaluate the implications of its short run decisions about fixed costs, marginal costs, sales volume and selling price for its profit plans on a continuous basis.The CVP analysis is very much useful to management as it provides an insight into the effects and inter-relationship of factors, which influence the profits of the firm. The relationship between cost, volume and profit makes up the profit structure of an enterprise. Hence, the CVP relationship becomes essential for budgeting and profit planning.As a starting point in profit planning, it helps to determine the maximum sales volume to avoid losses, and the sales volume at which the profit goal of the firm will be achieved. As an ultimate objective it helps management to find the most profitable combination of costs and volume.

Example