Managerial Accounting CVP Analysis Cost-Volume-Profit

Managerial Accounting

CVP Analysis

Cost-Volume-Profit Analysis is an integral part of managerial accounting because it can help the CEO to make vital decisions regarding the operations and future of the company. It can be used by the CEO to get an estimate of future revenue, cost and profit. It can also be used by the CEO to know the exact activity and operational levels required to break even. This analysis can help the CEO to plan operations and to monitor the performance of the company.

Contribution Margin

Contribution margin, in simple terms, is the marginal profit obtained by the company from the sale of a unit of a product. In other words, it is the price of the unit minus the cost incurred to product that unit. It is the amount of money that is contributed by the sale of each unit to the overall profitability of the company.

Any manager would want the contribution figure to be higher because it is used to offset the fixed costs incurred by the company. This is the reason a firm with high Selling, General and Administration Expenses (SG&a) must have a higher contribution margin. These are the fixed costs incurred by the company and a higher contribution margin will help to offset these high fixed costs.

A company engaged in television production is a good example of a company that can incur high SG&a expenses. This is because they tend to spend a lot of resources on marketing and this can considerably add to their fixed costs. Also, these costs are not directly attributable to production and this makes it vital that the company keeps these expenses under constant control.

Calculations

Break-even point

Break-even point = Fixed costs / (Unit Selling Price -- Unit Variable Cost)

Break-even point for the given data = 500,000 / (20-10) = 50,000

So, the firm has to sell 50,000 units at the current price levels to break-even. The break-even point in terms of dollars is 50,000 * $20 = $1,000,000

Increased Sale Price

When the sale price is increased to $25, the revenue required to break even is $1,250,000.

The firm is estimated to lose 10% of sales, so the units sold will be 45,000. This will bring the revenue to $1,125,000. So the expected profitability will be $125,000.

It is not a good idea not to increase the price because the company should look at expanding the reach of its products, which is to increase the sales. This can bring profitability for the company in the long-run.