Quiz 9: Short-Term Profit Planning: Cost-Volume-Profit Cvp Analysis
Break-Even point: It is a point at which gains equal losses; it means there are no gains and losses by doing that particular task. At this break-even point cost or expenses are equal to revenue. This break-even point will be calculated by the following formulas. • Cost-volume-profit (CVP) analysis extends the use of information provided by breakeven analysis. • The main important part of CVP analysis is the point, where total revenues equal total costs. That is both fixed and variable. • At this breakeven point (BEP), an enterprise will experience no income or loss. • This BEP is an initial examination, which is done previous to the more detailed CVP analyses. Cost-volume-profit analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are: 1. CVP analysis studies the behavior of both costs and revenues simultaneous throughout the relevant range of activity. (This assumption resembles the concept of volume discounts on either purchased materials or sales.) 2. CVP is useful for classifying accurately, as either fixed or variable. 3. Changes in activity are the only factors that affect costs. 4. All units produced are sold (there is no ending finished goods inventory). 5. When a company sells more than one type of product, the sales mix (the ratio of each product to total sales) will remain constant. • Finding the breakeven point is the initial step in CVP, since it is most important to know whether sales at a given level will at least cover the relevant costs. The breakeven point can be determined with a mathematical equation, using contribution margin, or from a CVP graph.
Contribution Margin: The contribution margin ratio of the total contribution margin of a single unit to the selling price of that unit. It's the ratio of contribution margin to sales. It's the alteration in the operating profit linked with the modification in the sales price per unit. This ratio is useful for a decent estimate of the selling price per unit to achieve the breakeven. The contribution margin is the distinction between the full revenue and total variable value. It's an associate degree pointer that shows the modifications in operational financial gain that changes in the range of units sold. The formula for contribution margin is as follows: For example, when the selling price for a product A is $90 and its variable cost is $50. Then the contribution margin ratio is calculated as follows: So, the contribution margin ratio is 44.44%. This ratio helps to recognize the probable increase/decrease in the operating profit with respect to any changes in the selling price per unit.
Cost volume and profit analysis is a technique that scrutinizes the variation in cost and volume levels and its effect on profit. This technique examines the effect of operating decisions on short-term profit. It defines the relationship between selling price, fixed cost, the variable value, price at which per unit can be sold and the output level. CVP analysis relies on a few assumptions. They are as follows: 1. For a given range of output, the revenue activity and the overall cost(fixed cost and variable cost) are probable to be linear. The assumption is based on a given CVP model on a given vary of activity and these are not valid outside of the appropriate range. 2. There are two components of total cost: fixed cost and variable cost. Fixed costs stay constant with a rise and reduce within the units of goods and services produced or sold. A fixed cost remains unchanged in total in a given period despite wide variation in the total activity and volume. Variable costs modify in proportion with a rise and reduce in the units of goods and services produced or sold. A variable cost changes in total in a given period with vary in the total activity and volume.