Applications of Cost-Volume Profit (CVP) Analysis
CVP relationships information which is useful to managers in a wide variety of planning decisions. Managers use this analytical technique to accomplish far more than just the determination of a break-even point.
The following problems are based on the information given for company X:
S.P (Sales Price) per unit = $25
Variable Cost per unit = $15
Fixed costs for related time period = $30,000
Total sales made by Company X are $100,000.
1). A 10% reduction in selling price per unit.
New S.P. per unit = 25 – (25 x 10%) = $22.50
New Contribution margin per unit = 22.50 – 15 = $7.50
With fixed costs remaining unchanged, the new B.E point is:
= 30,000 / 7.5 = 4,000 units
The management may find the proposed changes desirable if, in the long run, sales are expected to increase.
2). The management believes that with a 10% reduction in selling price per unit, demand is expected to increase by 25%. What effect would this change have on profits? Is this a viable proposition?
|Sales||1,00,000 (4,000 @ $25)|
|Variable Costs (4,000 @ $15)||60,000|
|B.E point||3,000 units|
With a reduction in Sales Price per unit and an increase in Sales by 25%, the relevant calculations are shown below:
New S.P. per unit = $22.50
Sales = 5,000 units
Sales (5,000 @ 22.50) = $1,12,500
Variable Costs (5,000 @ 15) = 75,000
Contribution Margin = 37,500
Fixed Costs = 30,000
Net Profit = 7,500
B.E point = 4,000 units
B.E sales revenue = 90,000
P/V Ratio = 33.33%
MOS ratio = 20%
The proposed change is not desirable as net profits have decreased by $2,500, B.E point has increased to 4,000 units and bot P/V ratio and MOS ratio have also decreased.
Hence these examples serve to demonstrate that cost-volume-profit analysis can be used to solve a variety of business problems. It is a powerful tool that is used in conjunction with variable costing in order to improve the decision-making process.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.