Cost volume profit analysis

Cost Volume Profit Analysis

The Cost Volume Profit analysis is an accounting tool that helps business managers to examine the relationship established between fixed and variable costs, volume, and profits. Basically, the CVP analysis is able to determine what are the most profitable products or services that a company has to offer, to determine scenarios in case of sales volume drops, how low they can drop, how low prices can be decreased in order to sell more, or what happens in case the company takes out a loan (Toolkit, 2008). The CVP analysis involves three main tools: breakeven analysis, contribution margin analysis, and operating leverage. Breakeven analysis is responsible for determining the sales volume required for breaking even, under different price or cost levels. Contribution margin analysis focuses on comparing the profitability of different products or services that a company offers. Operating leverage is used for examining how the company uses fixed costs, which is related to sales increases. The CVP analysis can be used as a graph, on the one hand, or as an equation, on the other hand. Although its applicability is related to management accounting mostly, CVP analysis can also be applied in the marketing activity. In this case, CVP analysis is used in order to determine the maximum profit point that a company can obtain, since the company is involved in certain marketing activities, in relation to their costs and the sales volume they are able to generate (Wikipedia, 2008). Also related to marketing, CVP analysis is very helpful in determining marketing strategies and establishing goals and objectives that can really be attained. The CVP analysis is mostly helpful when applied in the case of small business. In the case of a small business, the financial and the accounting situation are not as complex as in the case of larger companies or corporations, which means that CVP is the perfect toll for analyzing certain facts regarding a company's financial performance and its future evolution. CVP is very useful for small business also because the analysis takes into consideration variables like Return on Investment, or Customer Acquisition Cost. This analysis allows the company to determine what the maximum profit volume can be, and how the above mentioned variables can be changed in order to become successful. CVP analysis is also able to determine the results of media campaigns, especially for small business, where results are more visible and can be observed after a shorter period of time. Furthermore, these results can be translated into a successful company strategy, given the fact that the strategy would be based on verified results. In relation to this, market share can increase due to such a strategy. For small business, CVP analysis is also used in establishing the company's budget for certain activities. The analysis is able to provide a flexible budget variant, which is exactly what a small company needs, given the fact that environmental changes affect small companies more than they affect larger companies. Such changes are quite difficult to be counteracted by a small company without a flexible budget. However, the CVP analysis has its disadvantages. According to critiques, the analysis uses simplifying assumptions, like deterministic and linear cost and revenue functions (Kee, 2007). Also, this method only concentrates on one product at a time, and on one period at a time. All in all, several surveys have revealed that the CVP analysis is one of the most widely used methods in management accounting.