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05 March, 2022

COST VOLUME PROFIT ANALYSIS

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

Describe briefly the uses of Financial Statement Analysis

 Analysis of the statement of financial position referred to as a balance sheet analysis, reports on a companys assets, liabilities, and ownership equity at a given point in time.

1. A financial statement analysis provides information on the operation of the enterprise. These include sale and the various expenses incurred during the processing state.

2. Financial statement analysis gives information about the changes in equity which helps to explain the changes of the companys equity throughout the reporting period.

3. Financial statement analysis provides information about cash flows which helps to prepare report on companys cash flow activities, particularly its operating, investing and financial activities.

Describe the Limitations of Financial Statement Analysis

 Although financial statement analysis is highly useful tools, it has limitations also. The limitations involve the comparability of financial data between companies and the need to look beyond ratios.

Comparison of one company with another can provide valuable clues about the financial health of an organization.

The analyst should keep in mind the lack of comparability of the data before drawing any definite conclusion. Comparisons of key ratios with other companies and with industry average often suggest avenues for further investigation.

Describe the necessity of Financial Statement Analysis.

 Holding of Share:

Shareholders are the owners of the company. The financial statement analysis is important as it provides meaningful information to the shareholders in taking decisions.

Decisions And Plans:

The management of the company is responsible for taking decisions and formulating planand policies for the future. They, therefore, always need to evaluate its performance and effectiveness of their action to realize the company's goal in the past. For that purpose, financial statement analysis is important to the company's management.

Extension Of Credit:

The creditors are the providers of loan capital to the company. Therefore they may have to take decisions as to whether they have to extend their loans to the company and demand fohigher interest rates. The financial statement analysis provides important information to them for their purpose.

Investment Decision:

The prospective investors are those who have surplus capital to invest in some profitable opportunities. Therefore, they often have to decide whether to invest their capital in the company's share. The financial statement analysis is important to them because they can obtain useful information for their investment decision making purpose.