Cost-Volume-Profit Analysis

For an effective decision making, the distinction between long term and short term is very important. Essentially, long term is planning for change by short term is adapting to change. This being the case, the resources of the former plant in the long-term to gain an advantage of changing opportunities. In the short term, on the other hand, the phones freedom of action is restricted as the output capacity is fixed. Assuming that output capacity of the form is fixed, a the short term planning involves selection of a desirable course of action whereby a planned profit can be achieved. It is here, the cost volume profit analysis would be very much useful as an important tool of planning. Because as the bearing name implies, it is the analysis of three different factors cost, volume and profit. In the analysis the following questions need to be answered.

a) what would be cost of production under varied circumstances ?

b) what would be volume of production ? And

c) what could be the profit ?

Nevertheless, it should be remembered that none of the above questions can be answer in isolation. Each question has necessary to the answer in relation to others because of their interdependence.

Concept of cost-volume-profit relationship:

Decision-making, principally, is selection of a course of action among various alternative available. Maybe whether to accept a particular business at specified price or not, whether to boost of the sales of one product or other. In the analysis of cost volume profit relationship, an attempt would be made to measure the variation of cost with volume. The cost depends upon the volume of production which, in its turn, depends upon the demand in the market. Profit depends upon the price that can be charged for the products and the cast there of. As such, even though the volume of production is increased profit need not necessary be high, when the prices fall down.

It should be noted in the context that every business form has to include some amount of fixed charges irrespective of the volume of production. These charges have to met out of the marginal profit made on each unit of production. Hence a minimum volume of business becomes essential to obviate the occurrence of losses. However, the direct variable cost of each unit would have to be covered by sale proceeds. 

Importance of cost volume profit analysis: 

As has been referred above, the interdependence of the three factors cost, volume and profit should thoroughly be comprehended. Sach comprehension would be greatly helpful to management in solving quite a lot of problems involving planning and control. The entire profit structure of a firm is dependent, upon the relationship between cost volume and profit. Budgeting and profit planning are hardly possible without CVP analysis. Thorough analysis makes it possible to isolate the effects of changes in volume, selling prices and variable costs. CVP analysis is useful in arriving at the pricing strategy. It is also relevant to the selection of best sales mix, when a firm produces several products. Under such circumstances it is important that a profit table combination of different products is selected with the due consideration to cost of production and prices that can be secured. A sales mix which is less profitable may, sometimes we decided to be produced with a view to penetrate the market and establish a stronger position from the sales point of view. Again the CVP analysis enables management to judge the cost of that kind of strategy in terms of profit lost. Analysis also emphasizes the cost behaviour pattern through various volumes of production as a guide to the selection of profit targets.