Benefits of using Cost Volume Profit analysis

Benefits of using follow Volume boodle analysisCost Volume Profit AnalysisTable of contentIntroductionCVP analysis and decision devisingRelationship between revenues, appeals, gets and volumeFixed vs. variable costs crumble even analysis boundary line of safe1.Non- Linear CVP analysis2.Linear CVP analysisOperating LeverageIncome Tax upbeatsFuture forecastingPrepaproportionn of BudgetsCost ControlPrice DeterminusinationProfit PlanningRisk AssessmentDecision MakingConclusionReferencesDescribe the benefits of using cost volume profit analysis for management decision fashioning IntroductionEvery organization needs to calculate future revenues in order to helper the managers carry out their trading operations effectively. Cost volume is the start used for this purpose. Cost Volume Profit analysis or CVP analysis helps in identifying the operating activity trains with a purpose to avoid any variant of losses and achieve gelt. Moreover, it also helps the companies to plan the ir future operations and see whether their organizational performance is going on the right track or non (Lewis). While conducting a course, the companies also hasten to face various risks and in order to counter those risks, CVP analysis is an effective apparatus.The following project tends to analyze the cardinal concepts regarding cost volume profit analysis along with an illustration of how these concepts crowd out be useful in carrying out organizational operations.CVP analysis and decision makingCost Volume Profit analysis helps organizations to examine their profits, costs and prices with respect to any changed that occur in gross sales volume. CVP is an effective tool that helps accountants to engage in decision making regarding future operations (Breakeven analysis (CVP analysis)). Moreover, it also helps in making the following decisions for the ac associationIt helps to analyze which products and services are beneficial and how jackpot partnership use these prod ucts and services to generate the maximum marrow of revenue.It also explains what sales volume will be needed by the order in order to achieve a fixed level of profitsMoreover, it tells how much revenue should the company target so as to make sure that no losses occurIt also highlights what would be expected budget of the companyIt also helps to calculate companys fixed costs and measure the amount of risk associated with any investmentRelationship between revenues, costs, profits and volumeCVP analysis helps to find out the relationship between the above mentioned elements in a graphical format. For sample if a company has contri exception shore of 300, 400 and 500 units respectively on its income statements, then the CVP graph butt joint be be as followsThe contribution allowance ratio used for this purpose house be cipher as followsCM ratio = tally CM Total SalesThis ratio keep be used to calculate unit contribution margin and the gist contribution margin (MAAW, 2011) . The unit contribution margin helps us to calculate the difference between total revenues and unit costs of the company whereas the total contribution margin is related to the difference between total revenues and the total costs of a company. In other words, the total can be calculated by multiplying the unit cost with the total number of units. So, this shows can CVP is an effective tool for calculating the contribution margin.Fixed vs. variable costsA nonher benefit that organizations get by using the cost volume profit analysis is the decision making about various types of costs. This is important because while carrying out a business, the company is not concerned with the total amount preferably it is concerned with the actual cost behavior. This is so because cost behavior helps us to classify the costs into various categories such(prenominal) as fixed, variable, administrative and so on. For exampleLets take a company with fixed costs F, variable costs V and the total numb er of units equal to X, its contribution margin will be equal to (P-V)X and profit can be calculated as followsProfit = (P-V) X FBreak even analysisCost volume profit analysis can also help the organizations in calculating the breakeven apex which is the point at which the profits become equal to zero. This can be done by finding the break even volume and then using it to make graphical representations. The break even volume can either be expressed in dollars or in units depending upon the nature and type of the organization (Cafferky, 2010). For instance if the organization makes a large amounts of products, then the company moldiness prefer to calculate the breakeven volume in the form of sales dollars while in case of one product company, the unit method world power be a more effective calculation of sales volume.Presented below are the calculation method and the graphical representation in both casesBreak even volume in unit method = Fixed costs Unit contribution margin Brea k even volume in sales dollar method = Fixed costs Contribution margin ratioThis chart illustrated that at the breakeven point, the profits of the company become zero and below this point, the company begins to incur losses. So, it is a beneficial tool for the organizations which help them to analyze what should be the target ad how this target can be achieved by managing the fixed as well as variable costs and also by preparing a plan for the future operations.Margin of safetyA new element introduced in this chart is the margin of safety which refers to the amount by which the sales revenues of a company might decrease because it begins to incur any losses. It is also called as the shock of loss which provides a deeper insight into the companys profits, losses and revenues. It can be calculated as followsMargin of Safety = Sales Breakeven salesMarin of safety ratio = Margin of safetySalesLarger ratios are preferred because they indicate that there is a lower risk that the company would reach breakeven point of even below it.This is the simplest method of calculating the breakeven point. However, it is not the only one. There are deuce types of methods used by different companies in order to benefit from the CVP approach (Yunkera Yunker, 2003).1. Non- Linear CVP analysisThis approach is used mostly for the purpose of economics in order to calculate various elements such as productiveness and returns in the long run. However, this has not proved to be a really good approach because it has unreliable input parameters. Since it is designed specifically for the long term transactions, therefore it is not really credible and reliable approach for making short term business calculations. Moreover, it has been found to be more complex as compared to the simple breakeven calculation.2. Linear CVP analysisThis is more realistic, practical and reliable approach to find the relationship between costs and revenues. It is the breakeven method that presents the things in a or else simple and easy to understand way. However, in order to make this approach a more effective one, the following 5 things need to be followed tutelage the sale price constantKeeping the variable cost per unit also constantThe total fixed costs must also ride out the sameIn case of more than one product lines, the company should try to keep the sales volume constantThe number of units sold must be equal to the number of units produced.Operating LeverageAnother benefit that companies gain by using the CVP approach is the operating leverage benefit which explains how the cost structure of an organization is made up of fixed cost processes. This is a huge benefit because the cost structure is directly related to the level of development and profit a company has (Phillips, 1994).Operating leverage can vary greatly from one company to another. In the firms that have a high ratio of fixed costs as compared to the variable costs, the operating leverage is good because it produces a high contribution margin. Similarly, higher fixed sales also mean that the company has a higher breakeven point. A higher breakeven point is directly related to the financial success of the company because at this point, the company can use up high profits at a much higher rate (Raichura, 2007).Income Tax benefitsSimilarly, the simple CVP model can be extended to other issues such as the calculation of incorporate taxes of multiple products within a company. This is done by modifying the profit equation of the chart to include taxes as well. This analysis can also be extended to those firms that offer more than one product or service rather than a simple product. This can be calculated as followsAfter tax profit = (P-V) X F x (1 t)Future forecastingBy using the above mentioned models, approaches and graphs, managers can analyze the direction in which their company is moving and this analysis might help them to better understand the different operations and activities within the organizations. By getting beforehand knowledge of profits and costs, the company can manage them in a more efficient way to adjoin productivity.Preparation of BudgetsSince the cost profit volume analysis helps in determining the level of sales and thus helps organizations to achieve their desire targets. This approach would help the managers to prepare their budgets which consist of the costs as well as the revenues at any level of production within the organization.Cost ControlThe biggest benefit of CVP analysis is to evaluate the cost volume changes within an organization and the impact of these changes on revenue generation. For instance there is a dental hospital that wants to purchase a new dental machine so that the patients level of satisfaction can be increased by reducing the time required for dental treatment. The purchase of this new machine will tend to increase fixed costs of an organization.So, at such complex situations, the cost volume analysis can be the most effective tool to help in simplifying the companys decision. If this dental hospital uses CVP analysis, it can manage to decrease its variable costs by maintain the profit at the same desired level.Price DeterminationIt is another benefit of using this approach. For example taking the above example again, if any competitor within the dental industry has caste the price at AED 50,000 for a single dental operation and the business cannot provide this operation at any cost lower than AED 20,000, then the company can use cost profit volume analysis to compare the competitors price with the fixed and variable costs of its own operations and thus it can manage to come up with a price that is in the best interest of the company.Profit PlanningThe aim of any business is to create value for the customers and to get profits for the company. However, managing all operations and costs in such a way that can maximize profits is not an easy task. Therefore, organizations have to consider a crew of things in order to engage in proper profit planning techniques. The CVP analysis can help the companies to create the best and most profitable combination of cost, price and sales volume. Thus, it can help managers to calculate and estimate their profit at different levels and for different range of products.Risk AssessmentThe business world is changing and due to several internal s well as external threats associated with any industry, businesses have to face too many risks. Although the calculation of risk and return through measuring a constant (beta) is a method in finance but managerial accounting is also concerned with this. Managing risk is too significant for any business because it tends to define all the procedures and practices involved within an organization.Therefore, CVP is a tool which helps to calculate risk particularly in terms of costs and volumes. After analyzing this risk, the companies can come up with efficient solutions to reduce this risk.Decision Making all in all the above mentioned benefits re directly or indirectly related to the decision making processes of a company. Any business organization has to make a lot of decisions regarding their price, their costs, and products, fixed and variable unit costs and so on. The CVP approach simplifies this process by providing the companies with a breakeven point and by helping them to engage in better decision making and planning for the future.ConclusionSo, the project has presented a detailed analysis of how is CVP calculated and how can it be used to benefit an organization. Out of the two types of CVP approaches, linear approach is the simple one and it provides companies with easy ways to make estimates regarding costs, prices and sales volumes. The calculation of breakeven pint helps in decision making for a company by providing it a better future forecasting, risk assessment,, price estimation and so on. In other word, the cost volume profit approach has a direct impact on improv ing the organizational performance and productivity.ReferencesBreakeven analysis (CVP analysis). (n.d.). Retrieved 4 9, 2014, from http//www.acornlive.com/demos/pdf/P2_PM_Chapter_5.pdfCafferky, M. (2010). Breakeven Analysis The Definitive Guide to Cost-Volume-Profit Analysis. Business Expert Press.Lewis, J. (n.d.). Advantages Disadvantages of Cost-Volume-Profit Analysis. Retrieved 4 9, 2014, from http//smallbusiness.chron.com/advantages-disadvantages-costvolumeprofit-analysis-35135.htmlMAAW. (2011). The dissension over contribution margin approach.Phillips, P. A. (1994). Welsh Hotel Cost-Volume-Profit Analysis and Uncertainty. International Journal of Contemporary 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.htmlYunkera, J. A., Yunker, P. J. (2003). Stochastic CVP analysis as a gateway to decision-making under unc ertainty. Journal of accounting Education, 339-365.