How does the firm use “Cost-Volume-Profit Analysis” to assess performance? How would you use such a system to measure how costs change as production changes? How do you develop a “break even analysis”...

CVP Analysis 1
Contents
Introduction ......................................................................................................................... 2
Assumptions of CVP analysis ............................................................................................. 2
Steps for implementing CVP analysis ................................................................................ 3
Economic Break even analysis ........................................................................................... 4
Margin of safety .................................................................................................................. 4
Practical illustration ............................................................................................................ 4
Graphical presentation of CVP analysis ............................................................................. 7
Epilogue .............................................................................................................................. 9
References ......................................................................................................................... 10
CVP Analysis 2

Introduction
Among various duties of managers one is to forecast the revenues, costs, production level
etc. Forecasting is done to plan in advance the future course of action and resources required to
fulfill them. Managers use various techniques in forecasting and among them CVP analysis is
one. CVP analysis helps in determining the level of operating activities required in order to avoid
losses in future and earn a predetermined sum of money. (Brewer, 5
th
Ed)
CVP analysis is a very useful toll which organizations uses to avoid losses, plan the
future level of operating activities, forecasting the requirement of funds so that organization can
determine source of funds in advance etc. The most basis role of CVP analysis is to determine
the future level of production and analyze how variations in costs and volume affect a company's
operating income and net income. (Brewer, 5
th
Ed)
Assumptions of CVP analysis
As we know every technique used in finance for the purpose of analysis has its own
assumption and limitation, this technique also have its own limitation and uses various
assumption. Various assumptions are required to be made for conducting cost volume profit
analysis which is given as follows: (Brewer, 5
th
Ed)
• Sales price per unit is constant.
• Variable costs per unit are constant.
• Total fixed costs are constant.
• Entire production is sold.
• Costs are only affected by the change in activity level.
• If a company sells more than one product, they are sold in the same mix.
CVP Analysis 3

Above mentioned assumption are necessary to make CVP model work, few of these
limitation are unrealistic still in order to make the model work we have to follow them.
Steps for implementing CVP analysis
 First step is to determine the selling price per unit to be charged from the
customer.
 Second step is to segregate all company's costs, including manufacturing, selling,
and administrative costs as variable or fixed.
 Third step is to add all the variable costs including manufacturing, selling and
admin and then compute the per unit variable cost.
 Once we get selling price per unit and variable cost per unit we can determine the
contribution margin. Contribution margin is the surplus of sales price over variable cost.
 Last step is to determine the total fixed costs which include manufacturing, selling
and admin costs.
Once...