Cost Of Sales And Cost Of Goods Sold Formula How Cost-Volume-Profit Analysis Helps in Profit Planning

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How Cost-Volume-Profit Analysis Helps in Profit Planning

Cost-Volume-Profit analysis is a method used to analyze how various operating decisions and marketing decisions will affect profits. This planning tool analyzes the impact of changes in volume, marketing mix, selling price, variable costs, fixed costs and profit. CVP analysis is often called break-ven analysis. It’s a simple model that assumes sales volume is the main cost driver. CVP analysis can be used to find the desired profit in revenue and strategy.

Income planning is used to determine the level of income required to reach a desired level of income. If a company wants to know the sales volume needed to achieve $65,000 a year in profit, they can use CVP analysis. The formula used to find the answer is, units sold= fixed cost + profit/ unit selling price – unit variable cost. This will give the company the number of units it needs to sell to get the profit it desires.

In cost planning decisions, managers will assume that the sales volume and the desired profit are now known. This is information we have received through income planning. The company now wants to find the value of the required variable costs or fixed costs to achieve the desired profit based on the assumed selling price. Companies will use CVP analysis when they have variable and fixed costs to incur. An example is that they plan to buy new equipment to be used in the production of goods. This new tool can reduce companies’ variable costs but increase fixed costs. CVP analysis will be used to determine how much variable costs would need to decrease to maintain their current level of profit. If variable costs will be too high, the company will fail to purchase equipment if it reduces its profits.

A real-world example would be an analysis of social security retirement benefits. Using data from the US Social Security Administration (www.ssa.gov), a person considering retirement can develop an interval model to determine when to apply for benefits. The question is, if someone delays applying until after age 62 (the earliest someone can apply for benefits), how long will it take for those larger payments (due to applying later) to add up to the total available. received by applying earlier? A good website gives the answer (www.social-security-table.com). For example, someone who decides to retire at age 65 or 70 can use analytics. Analysis shows that retirees who live beyond the age of 82 will receive a greater life expectancy (not adjusted for the time value of money) (Blocher, 227).

A company will use CVP analysis if it has other machines available for purchase. Some machines may cost more to purchase but may cost less to operate. Another machine may have a lower purchase price but higher operating costs. For example, if a body shop wants to buy an elevator, one elevator may cost them more to operate than a second. The company will evaluate this option by obtaining a sales figure. The amount of advertising will help them in deciding which machine to choose. If they produce a large amount of goods, it may be cheaper to go with a machine that has lower operating costs because they use the machine more often.

A third example of cost planning is changing wages and commissions. If the company wishes to reduce the commission rate to increase the salary of their employees. They will use CVP analysis to determine how much they need to reduce their commission rate in order to maintain the same profit and increase in income that sellers are asking for. Firms in a variety of industries have found the CVP model useful for both strategic decisions and long-term planning. Furthermore, a survey of management accounting practices shows that CVP analysis is one of the most widely used methods (Garg et al., 2003). A number of limitations must be considered in using interval analysis. For example, we assume that total costs and unit variable costs do not change.

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