When a production process takes place, there are multiple aspects that need to be taken into consideration. Starting from what volume is to be produced to what would be the adequate price for that and finally, total profits that are ascertained in production of that product. To ensure that this computation of data is done in the best manner, it is important that there be certain tools that provide an analysis of these data.
This analytical tool can be defined as cost volume profit analysis.
Understanding the cost-profit-volume analysis:
This is an analytical tool with the help of which, relation between volume, cost, profit and price of a product can be determined. With help of this, variations in regards to these facets of production are measured analytically.
Heiser defines this tool as, the sole factor that is associated with profit planning in regards to this business is relation between volumes of business costs and profits incurred.
Facets of study in this analysis:
To understand this above mentioned relation in a detailed manner, it is important to study certain points:
There are times when the management wishes to know of the profitability of a particular product. In such a scenario, taking help from such analysis is extremely helpful.
Understanding the various points to be noted:
Profit Volume Ratio:
Having a very important role in decision making, this is used for calculating BEP and other aspects associated with profit and sales relation. With a high PV ratio, a company can obtain higher profits and vice versa.
Margin of Safety:
This can be clearly defined as extra production or actual sales over break even production or sales in case of a selected activity.
Break Even Analysis:
This is the most important financial tool that determines the impact on profit, costs of price and sales, and changes in volume of production. With help of this tool, levels of efficiency can be measured in the most accurate manner.
Break Even Chart:
The graphical representation of break-even point is known as break even chart. According to Dr. Vance, ‘’This graph specifically shows the amount of fixed variable costs along with sales revenue that is garnered at specific operative volumes. It also depicts that point when the firm covers all costs associated with break-even revenue.
Presumptions made with break-even analysis:
Positives associated with Break Even Analysis and Chart:
BEP = Fixed Cost x Sales
Sales – Variable Cost
Angle of Incidence:
This is an angle that is formed at the break-even point in a graph, where sales line cut off the total cost line showing the profit earning capacity. Profit is proportionate to the angle of incidence.