CVP analysis is also referred to as the Break Even Analysis. It refers to the use of marginal costing, and it seeks to understand the relationship between costs, volume, and profits at different activity level. It can be a useful tool for decision-making and short term planning (Debarshi, 2011). It is relevant where the proposed changes in the level of activity are relatively small so that established costs pattern and relationships are likely to hold goods. Due to changes in activity level in the long-term, the existing structures of cost such as the marginal costs and fixed costs per unit change and thus, CVP analysis may not produce useful guidance. Example of decisions where CVP analysis is used includes the pricing policies, special order acceptance, and choice of sale mix and in multi shift working. (Cafferky, 2010). CVP assumes that; fixed costs will remain fixed while the variable costs changes with the level of the activity, costs are classified as variable costs and fixed costs and it also assumes that the range of activity considering the revenue and costs assumes a linear version. There are two approaches to CVP analysis; the graphical approach and formula based approach.
Break-even point in dollar sales and in unit sales
Break even point refers to the point where the expenses and revenue are equal, that is, neither gain nor loss and therefore, one has broken even. Although the opportunity cost has been paid, no loss or profit has been made, capital has been adjusted to risk and the expected return (Noreen, 2010). Lower sales volumes means that the firm is unprofitable while a higher volume would indicate that the firm is performing well. Break-even point is stated as either break even in units or break even in sales and the formula used are as follows.
When the fixed salary is increased, the break-even units also increase and this can be explained by the fact that the employees feel motivated by high salary and thus they increase their output. In return, the company’s dollar sales also increase and therefore, I would recommend the changes since they increase the firm’s net operating income.
In conclusion, management of firms’ uses CVP analysis to make business decisions and for planning purposes. It is a good management tool since it compares all the firms’ costs and revenue generated.
Debarshi, B. (2011). Management Accounting. Mumbai: Pearson Education India.
Cafferky Michael, J. W. (2010). Break Even Analysis. New York: Business Expert Press.
Noreen, E. (2010). Managerial Accounting for Managers, 2nd Edition. Web.