Earning profits is one the major goal for all the business enterprises. The most important factor that can influence the earning of profit includes the volume of output or level of production. CVP analysis is basically concerned with determining the relationship of cost and profit to the volume of output.
If there is an increase or decrease in the level of production due to any reason, the management of business must try to see its effects on business and use some technique to aid the management in this regards. Cost volume profit analysis also known as break even analysis is one such technique and establishes the relationship of cost, volume and profits.
In performing this analysis there are several assumptions, which include:
- Selling price is constant at all sales volume.
- Factors prices are also constant.
- Efficiency and productivity remains unchanged.
- Fixed cost remains static and variable cost remains variable at different levels of output.
- Volume the only factor that effects cost and revenues.
- Volume of production is same as volume of sales.
# TYPES OF COST AND THEIR BEHAVIOUR:
At the heart of CVP analysis is the relationship between the various factors known as cost- volume and profit. Before understanding the relationship, it is important to study types of cost and their behaviour.
Variable cost is the cost that changes with the change in level of output. There is a positive relationship between variable cost and the level of output which means that the VC increase with increase in the level of output and vice versa.
Fixed expenses as the name suggests are fixed in nature and does not change with the level of production. It remains constant at all level of output such as rent, salary of general manager etc.
SEMI VARIABLE COST:
Some costs are partly fixed and partly variable. These are also sometimes referred as semi variable costs. For example: the salary of a sales person includes fixed salary and the commission.
# APPLICATION OR MERITS OF CVP ANALYSIS:
CVP analysis is a very useful tool for management because of the following merits:
1. COST CONTROL:
CVP analysis divides the total cost into fixed and variable. Fived cost can be reduced by top management and that too at very low extent while the variable cost can be controlled easily by low level management. So, this technique helps to reduce the variable cost as much possible and hence controls the total cost.
2. PROFIT PLANNING:
The technique is also helpful in planning future operations in such a way as to increase profits and then maintain that specified level of profit.
3. EVALUATION OF PERFORMANCE:
An enterprise consists of different products, departments, market coverage area etc. The CVP analysis helps in analyzing the performance of each sector. Any sector that gives higher contribution is preferred, if fixed costs remains same.
4. DECISION MAKING:
The technique helps the management in vital decision making, especially dealing with short term decisions. The important areas of decision making includes: making or buying decisions, fixing of selling price, suspending activities, alternate methods of production etc.