Relationship of Cost volume profit

Businesses use the concept of the cost-volume-profit relationship to analyze how changes in costs and volume affect their overhead expenses and net revenue. The Cost-Volume-Profit formula compares numerous relationships, such as the cost of producing things, the amount of merchandise sold, and the money received from the sale of merchandise. Businesses benefit from a better grasp of their profitability thanks to the cost-volume-profit relationship. Cost-volume-profit correlations are used by many companies and accountants to decide which products and services to sell. The link between cost, volume, and profit is crucial to managerial accounting. It focuses on assisting managers in making wise business decisions.
The concept of cost-volume-profit is crucial in management accounting. It Analysis gives a simple framework of analysis that accountants use to evaluate the financial impacts of a wide scope of decisions. Cost-Volume-Profit conducts a relationship between the expense of manufacturing products, the number of goods sold and profits made (Drury, 2013).

For a company to become healthy and profitable, its management team needs to understand the financial effect that the small decisions have on its business. For instance, the management needs to know the most profitable goods or services and what will happen if the volumes of sales drop. Cost-Volume-Profit evaluation helps businesses get some insights into the above questions and many others. Cost Volume Profit analysis is a form of determining the connection between fixed and variable costs, the volume of goods and profits generated (Drury, 2013)..

Cost-volume-profit relationship focuses on how profit and expenses shift with a shift in volume. By examining the correlations among these variables, management accountants have firm control over the processes of planning and decision-making. Despite the value of Cost-Volume-Profit relationships, it has some limitations. Management accountants must take into consideration these limitations when using Cost-Volume- Profit evaluation concepts. In management accounting financial data is utilized to prepare and manage many exercises of the business and to assist the administration in the process of decision making. Managerial accounting is meant for internal use by the company as opposed to financial management which is for external use (Garrison et al., 2010).   

The cost-volume-profit relationship is one of the most valuable tools management accountants have at their disposal. It assists them to gain knowledge on connections among cost, volume, and profit by concentrating on interplays among variables like the cost of goods, the quantity of goods produced, variable and fixed cost. Because Cost-Volume-Profit Analysis assists management accountants to understand the connection among cost, volume, and profit, it is an essential tool in various marketing decisions. Using Cost-Volume-Profit analysis companies make decisions on what form of pricing policy to implement, the goods and services to offer and what marketing strategy to use  (Garrison et al., 2010).   

The cost-volume-profit analysis predicts how shifts in costs, volume, and price impact a firm’s revenue. Cost-Volume-Profit is a reliable instrument for making decisions and planning. In fact, Cost-Volume-Profit is one of the universally accepted tools utilized by management accountants to make business decisions. Businesses utilize Cost-Volume-Profit Analysis to arrive at important concepts, like the break-even point. The break-even point is the time where total income matches total cost of doing business or a moment of zero profits. Startups always encounter losses at the beginning and consider their initial break-even point as very important. Many businesses do not experience their first break-even point until after several years. Furthermore, management accountants become keen on Cost-Volume-Profit Analysis when their companies are in financial trouble.

The Cost-Volume- Profit Analysis categorizes all costs into two groups, fixed and variable costs. Fixed costs are prices that do not vary with the number of units manufactured. These expenses always remain fixed. A classic case of a fixed expense is rent. No matter the number of units produced by a plant the rent paid will remain the same. On the other hand Variable costs, shift according to the volume of production. Examples of variable costs are raw materials that go into production, labor and energy. For instance, a baker would need more flour to manufacture an increased volume of snacks. However, the rent paid for the premises will remain constant (Drury, 2013). 

The Cost Volume Production analysis utilizes variable and fixed costs to predict the level of production and the profits linked to it. As the level production rises, the fixed costs make a tiny percentage of total revenue while variable expenses remain a fixed percentage. Management accountants evaluate these patterns to foretell what expenses, sales, and earnings a business will have in the coming days. In addition, they also utilize Cost-Volume-Profit analysis to determine the break-even moment in manufacturing processes. When the break-even point is drafted on the Cost-Volume-Profit graph, the sales, fixed costs, and variable expenses meet. This is an important idea because it indicates if the profits from a business will foot every expense linked to it.

Cost-volume-profit analysis is a managerial accounting tool utilized to predict how shift in expense and product volume impact changes in a firm's earnings. The tool is universally applied in companies and has many benefits. However, it has several limitations. Knowing the strengths and restrictions of Cost-Volume-Profit Analysis assists companies to decide if this tool is good for their businesses.

One significant advantage of Cost-Volume-Profit is easy of calculations. The cost-volume-profit analysis utilizes a standard collection of accounting formulas that apply to every analysis tool. To determine the change in variables you only need to insert numbers into the formulas. The ease of calculation makes it a valuable tool for small enterprises which are starting up and lack experience in accounting. Cost-Volume-Profit analysis does not have complicated jargons and terms associated with accounting. As a result, the development and understanding of Cost Volume Profit Analysis estimates is easy (Drury, 2013). 

One significant limitation of Cost-Volume-Profit is its accuracy. Cost- Volume-Profit relationship makes an assumption that all expenses in business are entirely fixed or entirely variable. Fixed expenses are costs that remain constant with fluctuation in production, like rent. Variable expenses shift at a constant speed as the units of production increase. Basic variable costs are labor and raw material. However, it is important to take note of the fact that there are various costs which possess a fixed and variable element, referred to as mixed costs (Cafferky, 2010). 

Cost-Volume-Profit analysis demands that all business costs like production and administrative cost should be classified as variable or fixed. Some of the most important calculations when conducting Cost-Volume-Profit analysis is contribution margin ratio and contribution margin. The contribution margin is the volume of revenue or gain a business made prior to subtracting its fixed expenses (Cafferky, 2010). 

For Cost-Volume-Profit relationship to be valuable, it makes several assumptions. The assumptions form the rules for analyzing correlations among costs, sales, profits and volume. The rules which management accountants follow when applying Cost Volume Profit Analysis include: every variable remains fixed apart from the volume. The rule implies that volume is the only variable that affects profits and costs and causes them to fluctuate. Variables like improved production efficiency and fluctuating sales are not taken into consideration. Another assumption is that just one good is under production and if there are other products under production, then their sale is in the same unit. Cumulative expenses and total income are linear variables. The above assumption insinuates that the variable expense per unit and the selling value per unit are constant. To calculate profit management accountants use variable costing because it supports profit analysis. Variable costing divides variable and fixed costs and handles fixed costs like a time cost instead of trying to assign it to goods (Cafferky, 2010). 

Cost volume profit analysis studies how costs and profits show a change caused by a shift in volume of production. Cost volume profit analysis assists management accountants to gain some insights on how company profit change as a result of shifts in the business variable cost, fixed costs, volume of production and selling price. To understand Cost volume profit analysis, we must first comprehend its variables. The relationship between the three variables, defines the fiscal planning of a company (Marshall et al., 2011). 

The variables in Cost Volume Profit analysis are cost, volume and profit. The triple fundamental components define the profitability of a business in the long term. The primary component of an enterprise is the cost. Every company incurs some expenses as it runs its daily operations. The second element is volume. Volume is the amount of goods a business generates and sells. An enterprise must determine in advance the volume of goods it will produce. Then the final variable is profit. Profit is the income generated from the sale of goods minus the operating costs like rent, labor and energy (Marshall et al., 2011). 

The cost of doing business the volume of sale and production are predictable factors. But the profits can only be determined the moment the company learns the amount of revenue it has got and the costs incurred while conducting business. Cost and volume are predictable because if the amount of sales rises the volume of production increases, which in turn, raise the production costs, which are labor, raw materials, rent and energy. Cost volume profit analysis assists the management in making various business decisions. It helps a business administration; in deciding the volume of goods it should produce to achieve set targets of profits. It also assists a company to determine its profitable services and products among an assortment of products it deals in, or it offers to its clients. Identifying the most valuable services and good assists the company to channel most of its resources and effort in areas that have high returns (Cafferky 2010). 

Besides, cost volume profit relationship also supports the enterprise to devise ways of covering a rise in fixed costs that often occur. For example, interest on a loan may increase the amount of the loan payable thereby increasing the fixed cost. In instances like those, the business must understand the sale volume it must achieve to cover the increase in fixed costs so that the targeted profits are met (Marshall et al., 2011). 

A cost-volume-profit study is a tool for examining the link between volume, cost and profits. Cost volume profit analysis is a segment of marginal costing. It is an essential component of the profit planning system of a company. However, the real profit planning and monitoring include the utilization of budgets, and the cost volume planning, analysis gives just a highlight of the process. Furthermore, it aids in the evaluating the reason and logic of budgets

The Cost Volume Profit evaluation gives an insight into the relationship of elements, which affect the revenue of an enterprise. The association between cost, volume and profit constitute the profit structure of the business. Therefore, the Cost-Volume-Profit relationship is a valuable tool for planning business profit and budgeting. As part of profit planning, it assists management accountants to decide the highest volume of sales to evade making losses. It also helps in determining the sales volume at which a business will achieve its profit target. In a nutshell, it supports management accountants to strike a balance between costs and volume so as to make profits. A progressive administration, hence, applies Cost-Volume-Profit evaluation to foretell the effects decisions about variable costs, marginal costs, fixed cost, and the volume of sales on its profit structure over time. To find the most rewarding blend of fixed cost, variable cost, sales volume and price, management accountants use cost volume profit analysis. If they reduce the fixed costs by a significant margin, they increase the revenue by narrowing the contribution margin. The contribution margin is cumulative profit minus entire variable costs.  Contribution margin is a valuable tool when examining the impacts of volume on revenue. Contribution margin gives as a picture on how much profit from each unit will cover fixed costs. The moment sufficient units are sold to foot every fixed cost, the contribution margin from the remaining sales is considered as profit (Cafferky, 2010). 

Accounting managers are always worried about the effect of their choice on the revenues of their companies. Managers make decisions about production volume, pricing system of their products, and the expenses. Hence, the management needs to have knowledge of the connection between costs, volume, and profit. The department of cost accounting is responsible for supplying data used for cost-volume-profit analysis. Cost-volume-profit evaluation assists the management in detecting the effect of other product pricing system on revenue. It is also helpful for assessing rivals’ pricing strategies and attempts to expand market share (Cafferky, 2010). 

Various companies utilize of Cost Volume Profit to determine the Impact of Various Cost Structures. A company’s cost structure is the size of fixed and variable expenses to the firm's total costs. Cost structures vary extensively in different sectors and among businesses in the same sector. For instance, companies that deal in electrical appliances like Samsung Electronics and Panasonic invest very highly in appliances; this results in a cost framework that has an enormous fixed cost. On other hand grocery stores, for example, have a cost structure which consists of a huge variable cost. The difference comes from the fact that electronic stores invest a lot in the capital while grocery stores invest a lot in labor. A firm’s cost structure has an enormous impact on its profits (Cafferky, 2010).  Accountants use the term operating leverage which is the degree to which a company’s cost structure consists of fixed costs. Operating leverage differs from company to company depending on its line of business. Firms that are labor-intensive have a high operating leverage than those that are not. Furthermore, huge variable costs lead to an enormous contribution margin. The larger a company’s fixed costs, the greater the break-even limit. Once a business reaches and breaks the break-even point, revenue grows exponentially (Cafferky, 2010).   

Each company has a sole objective of not just making a profit, but also making sure that the benefits are at their maximum. Making a profit is not something that occurs out of the blues. The management has to plan. Cost-volume-profit Analysis provides a basis for that planning. Cost Volume Planning analysis is essential for generating alternative approaches in sales planning. Meaningful connections exist between variables like volume and profits. Cost-volume-profit evaluation is a management accounting tool demonstrating the link between the variables. Cost Volume Profit Analysis, though widely applicable in the corporate sector, it is also appropriate in other organizations. In this organizations, they are used in the allocation of resources to different needs.

Company management must predict future revenues, operating costs, and profits to assist it in preparing and controlling operations. Managers apply cost-volume-profit evaluation to know the level of operating activity required to avoid losses, meet set target of profits, plan for business operations, and observe the performance of their companies. Cost-Volume-Profit analysis tools are used for decision making and planning process. The tools focus on the relationships of cost, quantity sold, and price. It examines the impacts of shifts in price and volume on a firms' revenue. It analyses management decisions like pricing system, deciding the type of product to deal with, and optimizing the utilization of the production line.

References

Cafferky, M. (2010). Breakeven Analysis: The definitive guide to cost-volume-profit analysis. Business Expert Press.

DRURY, C. M. (2013). Management and cost accounting. Springer.

Garrison, R. H., Noreen, E. W., Brewer, P. C., & McGowan, A. (2010). Managerial     accounting. Issues in Accounting Education, 25(4), 792-793.

Marshall, D. H., McManus, W. W., & Viele, D. F. (2011). Accounting. McGraw-Hill Irwin,.

Warren, C. S., Reeve, J. M., & Duchac, J. (2013). Financial & managerial accounting. Cengage Learning.