Cost Volume Profit Analysis

Abdelrahman Taera

Accounting

Assignment 2

-Discuss the importance of cost-volume profit analysis planning and decision making.

Cost-volume profit analysis is a managerial accounting method based on determining and calculating the Break-even point of cost and volume of goods, and it's helpful for managers to make short term decisions.

Costs are devided to :

1-fixed cost which is not affected by level of production.

2-variable cost which increase by increasing production.

Cost-volume profit analysis works under some assumptions in order to be relevant :

1- price per unit is constant.

2- fixed cost per unit is constant.

3- variable cost per unit is constant.

4- all units produced are sold (no ending inventory).

Break-even point is the point at which the company is not making any profits or losses, before the break-even point company is making losses and after it the company is making profits, as contribution is contributing in covering fixed cost before breakeven point and contributing in maximising profit after break even point.

The safty margin is the difference between the number of units produced and assumed to be sold and the number of units at the breakeven point.

Profit is equal contribution*safety margin.

The data needed for determining the break-even point :

1-price per unit

2-fixed cost

3-variable cost per unit.

Then some data are calculated :

1-total cost = fixed cost + ( variable cost per unit * number of units)

2-total revenues = price per unit * number of units sold

those two equations are linear because of the assumptions of constant fixed and variable cost per unit and price per unit, which means that if the number of units increase the total cost will increase as well as total revenues.

-contribution is the profit after deduction of variable cost from revenues.

contribution = sales - variable cost

so,

Total revenues = price per unit * number of units

                   = ( (price/unit - variable cost/unit)+variable cost/unit ) * number of units

                   = (contribution/unit + variable cost/unit) * number of units

                   = (contribution/unit * number of units)+(variable cost/unit * number of units)

profit = total revenues - total costs

 = ( (contribution/unit+variable cost/unit) * number of units )- ( total fixed cost+(variable cost/unit*number of units )

= contribution * number of units - total fixed cost.

so,

break even point = total fixed cost / contribution.

so if the price per unit is 30$ and the variable cost per unit is 14$ and total fixed cost is 18000$ so break even point is equal to

18000/(30-14)= 18000/16= 1125 units.

so before 1125 units business is making losses and after 1125 units business is making profits.

After calculating and determining the break-even point, the top management could decide how many units should they produce, and as well they can know what type of cost is increased so they can cut it off either fixed cost or variable cost, also they can check if they are going to make profits or losses upon the present costs and price per unit so upon it they can decide whether to increase price per unit or not also they can decide whether to spend more on the costs as employees or machinery or even raw materials or not.