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:
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.