Benefits of using Cost Size Profit analysis

Every organization needs to calculate future earnings in order to help the managers carry out their operations effectively. Cost size is the procedure used for this purpose. Cost Volume Income evaluation or CVP research helps in discovering the operating activity levels with a purpose to avoid any sort of losses and achieve income. Moreover, it also helps the companies to plan their future functions and see whether their organizational performance is going on the right track or not (Lewis). While doing a business, the companies also have to face various risks and in order to counter those hazards, CVP research is a powerful tool.

The following task tends to assess the fundamental ideas regarding cost level profit analysis along with an illustration of how these ideas can be useful in undertaking organizational functions.

CVP examination and decision making

Cost Volume Revenue evaluation helps organizations to look at their revenue, costs and prices regarding any modified that occur in sales size. CVP is a highly effective tool that helps accountants to engage in decision making regarding future businesses (Breakeven evaluation (CVP examination)). Furthermore, it also helps in making the following decisions for the business:

It helps to assess which products and services are beneficial and how can company use the products and services to create the maximum amount of revenue.
It also clarifies what sales size will be needed by the company in order to achieve a fixed level of profits
Moreover, it explains to how much earnings should the company target to be able to ensure that no loss occur
It also highlights what would be expected budget of the company
It also really helps to calculate company's set costs and gauge the amount of risk associated with any investment

Relationship between revenues, costs, income and volume

CVP research helps to find out the relationship between the previously listed elements in a graphical format. For example: in case a company has contribution margin of 300, 400 and 500 items respectively on its income claims, then your CVP graph can be symbolized the following:

The contribution margin percentage used for this purpose can be determined the following:

CM percentage = Total CM

Total Sales

This ratio can be used to calculate unit contribution margin and the total contribution margin (MAAW, 2011). The machine contribution margin helps us to compute the difference between total profits and unit costs of the company whereas the total contribution margin relates to the difference between total income and the full total costs of an company. Quite simply, the full total can be determined by multiplying the unit cost with the full total number of products. So, this shows can CVP is an efficient tool for determining the contribution margin.

Fixed vs. changing costs

Another advantage that organizations get by using the price volume profit research is the decision making about different kinds of costs. That is important because while following a business, the business is not concerned with the quantity rather it can be involved with the genuine cost behavior. That is so because cost action helps us to classify the expenses into various categories such as predetermined, variable, administrative and so forth. For instance:

Let's have a company with permanent costs F, variable costs V and the total number of products equal to X, its contribution margin will be add up to (P-V)X and income can be determined as follows:

Profit = (P-V) X - F

Break even examination:

Cost volume income analysis can also help the organizations in calculating the breakeven point which is the point at which the gains become add up to zero. This can be done by finding the break even volume and then using it to make graphical representations. The break even amount can either be indicated in dollars or in items depending upon the type and type of the organization (Cafferky, 2010). For instance: if the business makes a sizable amounts of products, then the company must want to assess the breakeven size by means of sales dollars while in case of one product company, the unit method might be considered a more effective computation of sales amount.

Presented below are the calculation method and the visual representation in both conditions:

Break even volume in product method = Fixed costs

Device contribution margin

Break even amount in sales dollars method = Fixed costs

Contribution margin ratio

This graph illustrated that at the breakeven point, the profits of the company become zero and below this point, the company starts to incur losses. So, it is a beneficial tool for the organizations that assist them to investigate what ought to be the target ad how this aim for can be achieved by managing the fixed as well as variable costs and also by planning a plan for the future operations.

Margin of safety

A new component released in this chart is the margin of basic safety which identifies the amount where the sales revenues of a company might reduce because it begins to incur any deficits. It is also called as the cushion of loss which provides a deeper information into the company's profits, deficits and revenues. It could be calculated as follows:

Margin of Security = Sales Breakeven sales

Marin of protection proportion = Margin of safety

Sales

Larger ratios are preferred because they signify that there surely is less risk that the company would reach breakeven point of even below it.

This is the simplest method of determining the breakeven point. However, it is not the only person. There are two types of methods used by different companies in order to take advantage of the CVP way (Yunkera & Yunker, 2003).

1. Non- Linear CVP examination:

This approach can be used mostly for the purpose of economics in order to calculate various elements such as efficiency and returns over time. However, it has not became a really good approach since it has unreliable suggestions parameters. Because it is designed designed for the long-term transactions, therefore; it isn't really credible and reliable procedure for making short-term business calculations. In addition, it has been found to become more complex as compared to the simple breakeven calculation.

2. Linear CVP analysis:

This is more practical, practical and reliable approach to find the partnership between costs and profits. It's the breakeven method that presents the items in a rather simple and "easy to understand way. However, in order to make this approach a far more effective one, the next 5 things have to be followed:

Keeping the deal price constant
Keeping the variable cost per unit also constant
The total permanent costs must also continue to be the same
In case of more than one product lines, the company should try to keep carefully the sales volume constant
The volume of items sold must be equal to the amount of units produced.

Operating Leverage

Another gain that companies gain utilizing the CVP way is the operating leverage advantage which explains how the cost composition of an organization comprises of fixed cost procedures. This is an enormous benefit because the cost structure is immediately related to the level of growth and revenue a firm has (Phillips, 1994).

Operating leverage can vary greatly from one company to another. In the businesses that have a higher ratio of set costs when compared with the changing costs, the operating leverage is good since it produces a higher contribution margin. Likewise, higher fixed sales also imply that the business has an increased breakeven point. A higher breakeven point is directly related to the financial success of the company because at this time, the company can promise high profits at a much higher rate (Raichura, 2007).

Income Taxes benefits:

Similarly, the easy CVP model can be long to other issues including the calculation of combine taxes of multiple products inside a company. That is done by modifying the profit equation of the graph to include fees as well. This research can also be extended to the people firms that provide several product or service rather than a simple product. This can be calculated the following:

After tax profit = [(P-V) X F] x (1 t)

Future forecasting

By using the above mentioned models, strategies and graphs, managers can examine the direction in which their company is moving which analysis will help them to raised understand different operations and activities within the organizations. By getting beforehand knowledge of profits and costs, the business can take care of them in a far more useful way to increase efficiency.

Preparation of Costs:

Since the price profit volume examination helps in determining the amount of sales and therefore helps organizations to attain their desired targets. This process would help the managers to prepare their costs which contain the costs as well as the profits at any level of production within the business.

Cost Control:

The biggest advantage of CVP analysis is to judge the cost quantity changes within an corporation and the impact of the changes on earnings generation. For instance: there is a dental clinic that wants to acquire a new oral machine so that the patient's degree of satisfaction can be increased by minimizing the time required for dental care. The purchase of the new machine will tend to increase set costs of a business.

So, at such complicated situations, the price volume analysis can be the most effective tool to help in simplifying the company's decision. If this oral medical center uses CVP analysis, it can manage to decrease its changing costs by keep up with the revenue at the same desired level.

Price Persistence:

It is another good thing about using this process. For example: taking the above example again, if any competition within the dental care industry has place the price at AED 50, 000 for an individual dental operation and the business cannot provide this operation at any cost less than AED 20, 000, then the company can use cost profit volume analysis to compare the rival's price with the set and varying costs of its own operations and therefore it can have the ability to think of a price that is in the best interest of the company.

Profit Planning:

The aim of any business is to build value for the clients also to get gains for the business. However, controlling all operations and costs so that can improve income is not an easy job. Therefore, organizations have to look at a whole lot of things in order to engage in proper revenue planning techniques. The CVP examination can help the companies to generate the best & most profitable combination of cost, price and sales amount. Thus, it can help managers to calculate and estimate their revenue at different levels and for different range of products.

Risk Diagnosis:

The business community is changing and anticipated to several interior s well as exterior dangers associated with any industry, businesses have to handle too many risks. Although the calculation of risk and go back through measuring a regular (beta) is a way in money but managerial accounting is also worried about this. Managing risk is too significant for just about any business since it tends to explain all the strategies and practices engaged within an organization.

Therefore, CVP is a tool which really helps to calculate risk especially in conditions of costs and amounts. After studying this risk, the companies will come up with effective solutions to reduce this risk.

Decision Making:

All the above mentioned benefits re immediately or indirectly related to your choice making processes of a company. Any business business has to make a whole lot of decisions regarding their price, their costs, and products, fixed and variable unit costs etc. The CVP methodology simplifies this technique by providing the companies with a breakeven point and by supporting them to activate in better decision making and planning for the near future.

Conclusion

So, the task has presented a detailed analysis of how is CVP calculated and how do it be used to benefit an organization. Out of the two types of CVP solutions, linear approach is the simple one and it offers companies with easy ways to make estimations regarding costs, prices and sales quantities. The calculation of breakeven pint assists with decision making for a firm by giving it a better future forecasting, risk assessment, , price estimation and so forth. In other term, the cost amount profit approach has a primary impact on improving the organizational performance and efficiency.

References

Breakeven analysis (CVP research). (n. d. ). Retrieved 4 9, 2014, from http://www. acornlive. com/demos/pdf/P2_PM_Chapter_5. pdf

Cafferky, M. (2010). Breakeven Analysis: The Definitive Guide to Cost-Volume-Profit Research. Business Expert Press.

Lewis, J. (n. d. ). Advantages & Drawbacks of Cost-Volume-Profit Research. Retrieved 4 9, 2014, from http://smallbusiness. chron. com/advantages-disadvantages-costvolumeprofit-analysis-35135. html

MAAW. (2011). The controversy over contribution margin way.

Phillips, P. A. (1994). Welsh Hotel: Cost-Volume-Profit Research and Doubt. International Journal of Modern Hospitality Management, 31-36.

Raichura, K. (2007). C-V-P Analysis & Operating Leverage. Retrieved 4 9, 2014, from http://www. managementparadise. com/forums/financial-management/20603-c-v-p-analysis-operating-leverage. html

Yunkera, J. A. , & Yunker, P. J. (2003). Stochastic CVP examination as a gateway to decision-making under uncertainty. Journal of accounting Education, 339-365.

Benefits of using Cost Quantity Profit analysis

Cost Volume Profit Analysis

Introduction