Cost-volume-profit analysis is a managerial accounting
technique used
to
analyze how changes in
cost
and sales volume affect changes in
a company's profit. The technique
is widely used in business and has many
advantages. Cost Volume
Profit (CVP) Analysis is an important
tool of
profit planning. Cost volume profit analysis helps the
management in profit planning.
The analytical technique used to study the behavior of profit in response to the changes in volume , cost and
prices is called the Cost – Volume – profit(CVP) analysis.
Because CVP analysis helps managers
understanding the interrelationship among cost, volume
and profit , it is a vital tool in many business decision. These decisions
include
, for example , what products to
manufacture or sell, what pricing policy to follow,
what marketing strategy to follow
and what type of productive facilities to acquire.
Advantages
or objectives of
cost volume profit
analysis
a. Profit planning
b. Maintaining a desired level of profit
c. Preparing flexible
sales and production
cost budgets
d. Fixation
of selling
price
e. Selection
of a profitable product Mix
f. Introduction of a new product
g. Closure
of
a department or discontinuing of a product
h. Choice of
technique
i. Level of activity
planning
j. Decision making
k. Evaluation
of
performance
Assumptions in CVP analysis
• The behavior of both costs
and
revenues is linear throughout the relevant range of the activity
index.
• All costs can be classified
with reasonable
accuracy as either variable or fixed .
• Changes in the activity are
the
only
factors
that affect costs.
• All units produced are
sold.
• Selling
price remains the same at different level of activity
• There is
no change in the product mix
• There is
no change in the level of efficiency
• Policies of management do not change
• As the number
of units produced
and sold are the
same , there
is no closing
or opening stock