MBA Accounting

Append below is a list of articles under Cost-Volume-Profit(Managerial Accounting:

Break-even point in Cost-Volume-Profit

Steps to follow in Using Contribution Margin in the Cost-Volume-Profit Relationship

Cost-Volume-Profit Relationships - Benefits or Objectives 

Limitation of Cost-Volume-Profit Analysis In Short Term Decision 

Introduction & Assumptions Made in Cost-Volume-Profit 

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Most managers would able to understand the term “break-even” which means there is no loss or gain.

Similarly, in the cost-volume-profit relationship, break even point(BEP) is the LEVEL OF SALES AT WHICH PROFIT IS ZERO. At this point , there is NO gain or loss

Refer to the below situation:

Total ($) Per unit($)

Sales ( 500 Product A) 200,000 550

Less: Variable expenses 50,000 200

Contribution margin 150,000 350

less: Fixed expenses 70,000

Net Operating Income 80,000

Salient points to note:

• Once the break even point has been reached, net operating income will increase by the unit contribution margin for each additional unit sold in this case $350
• Even if there is no sales, the company loss would equal to its fixed expense which is $70,000
• In the above case, there is ample profit, the decision maker can still price the products lower until the contribution margin= fixed expense which is the breakeven point level of sales.

As described earlier, managers whether with financial or non-financial knowledge needs to at least understand the cost-volume-profit relationship to make decisions. The steps to remember the main element namely Contribution Margin is very simple & basic:

• Contribution Margin(CM) is left after variable expenses have been deducted
• CM amount will cover fixed expenses
• After covering fixed cost, any remaining CM contributes to income
• If CM is not sufficient to cover fixed expenses, we then see a LOSS situation

Append below a simple illustration of a profitable scenario when using the Contribution margin basis:-

ABC Company

Contribution Income Statement For Jan 07

Total ($)     Per Unit($)

Sales (500 Product X)      500,000          1,000

less: Variable expenses    300,000           400

Contribution Margin         200,000           600

Less: Fixed expenses         70,000

Net Operating Income     130,000

Notes:

1. the CONTRIBUTION MARGIN(CM) namely the net operating income is the balance remaining from sales revenue after variable expenses have been deducted
2. Per Unit column is important to make decision
3. Note that the above information is only for the internal users and not external parties.

Cost-volume-profit relationships need to be understood by managers whether who have financial or non financial knowledge. This is because the cost-volume-profit relationship helps manager to make decision. It helps them to understand the interrelation between, cost, volume and profit in an organizatin by focusing interactions among the following elements:

1. Price of the product
2. Volume or level of activity
3. Per unit variable cost
4. Total fixed cost
5. Mix of product sold

The aforesaid elements would provide the managers the following answers:

• what product to manufacture or sell
• what pricing to follow
• what marketing strategy to employ
• what type of productive facilities to acquire

Managers who wish to deploy the Cost-Volume-Profit Analysis effectively, need to also understand some of the following limitations of this modelling tool:

Cost Volume Profit analysis is a short term decision making tool used to assist managers in understanding the behavior of total costs, total revenues and operating income as changes occur in the output level, selling prices, variable cost or fixed costs.

Cost Volume Profit analysis is able to show the impact on the organization profit given different set of sensitivity in selling prices, costs, income tax rates, product mix and others.

Normally Cost Volume Profit analysis involve the Break-even Calculation.

It is important to understand the CVP analysis are based on the following key assumptions: