Question

Why is Cost-Volume-Profit analysis useful? Why is it an important concept in managerial accounting?

Answer 1

• CVP Analysis is a technique for studying the relationship between cost, volume and profit.
• Profit of an undertaking depends on large number of factors. But most important of these factors are the cost of manufacture, volume of sales and selling price of products.
• The CVP relationship is an important tool used for profit planning of a business.
• As a starting point in profit planning, it helps to determine the maximum sales volume to avoid losses, and the sales volume at which the profit goal of the firm will be achieved. As an ultimate objective it helps management to find the most profitable combination of costs and volume.
• A dynamic management, therefore, uses CVP analysis to predict and evaluate the implications of its short run decisions about fixed costs, marginal costs, sales volume and selling price for its profit plans on a continuous basis.
• CVP analysis can help companies determine their contribution margin, which is the amount remaining from sales revenue after all variable expenses have been deducted. The amount that remains is first used to cover fixed costs, and whatever remains afterward is considered profit.
• By breaking down costs into fixed versus variable, CVP analysis gives companies strong insight into the profitability of their products or services.
• Many companies and accounting professionals use cost-volume-profit analysis to make informed decisions about the products or services they sell. In this regard, CVP analysis plays a larger role in managerial accounting than in financial accounting. Managerial accounting focuses on helping managers -- or those tasked with running businesses -- make smart, cost-effective moves.