What Is CVP Analysis
This is a managerial accounting technique that is used to affect the sales capacity and production costs on operating profit of a firm. it helps is assessing how the operating profits is affected by the variations in costs that include both fixed and variable and selling cost per unit of product produced. Managers must evaluate future revenues and costs to help them know what the profit margin the organization is getting. The CVP (cost – volume – profit) tool is very helpful for them in scrutinizing the operational risk by helping them in selecting the suitable cost structure.
The CVP analysis is based on assumptions. Here are certain assumptions which govern the cost profit volume analysis:
- All costs can be classified into fixed and variable: it stands on this assumption that it can classify all costs into fixed and variable. But the real fact is that in large organizations they are various costs involved that with a simple analysis it may be difficult to classify them into just two types.
- Fixed costs continue to be fixed over a range of activity: this assumption also does not hold good for those companies which would like use wide range of techniques. The company cannot assurance that the fixed costs will remain as fixed, because if the firm wants to produce at a level of production outside the given variety then sometimes the fixed cost may become variable in nature.
- Variable cost fluctuates directly with action: this assumption might be true to some extent. It is possible for certain costs to vary directly with definite activity. For example the cost of installation of certain machinery in the production unit may vary from time to time.
- Selling prices remain fixed per unit: here raises a question as to why the company has to sell the products at the same price for all customers. It makes sense that the company can very well offer different prices for different customers. For example the company might very well offer discounts to whole sellers who buy products in bulk.
- Vagueness does not exist: the final assumption of CVP analysis is that there is no vagueness. All is recognized, prices are certain, customers are certain etc.
Managers and Accountants must always assess the CVP relationship with other costs to generate precise results. However they might also come across multifaceted situations in which they can go ahead with applying CVP theory in order help them take suitable decisions under diverse situations. In all the managerial accountants must break even the three important components of cost, volume and profit.