Applications of Cost-Volume Profit (CVP) Analysis

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.

Example

The following problems are based on the information given for company X:

S.P (Sales Price) per unit = $25
Variable Cost per unit = $15
Fixed costs for related time period = $30,000

Total sales made by Company X are $100,000.

1). A 10% reduction in selling price per unit.

Solution:

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?

Sales1,00,000 (4,000 @ $25)
Variable Costs (4,000 @ $15)60,000
Contribution Margin40,000
Fixed Costs30,000
Net Profit10,000
B.E point3,000 units
B.E sales$75,000
P/V ratio40%
MOS Ratio25%

With a reduction in Sales Price per unit and an increase in Sales by 25%, the relevant calculations are shown below:

Also Check:  Assumptions and Limitations underlying CVP Analysis

New S.P. per unit = $22.50

Sales = 5,000 units

Changed Situation

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.

 

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