CVP analysis Essay Example | Topics and Well Written Essays - 1250 words

CVP analysis - Essay Example Cost–volume–profit (CVP) is an administrative management tool used in economics (Weygandt, 2009). It is a basic model designed to assist in making short-time decisions in economics based on costs incurred in the business The information on CVP influences determination of break-even analysis. Break-even spot shows the point at which the net income is zero. Analysis of CVP makes use of variable and fixed costs. CVP examines the dynamics experienced in profits accrued by businesses due to changes in the volumes of costs of various products and their sales. It is through CVP that a venture identifies the progress of his or her business and makes sound decisions. CVP analysis has a number of assumptions, which also are the same as those for break-even analysis. The analyst assumes that costs behave in a linear manner throughout the activities. The classification of costs is possible and accurately stated depending on whether fixed or variable. The other assumption is that ch anges in costs are due to change of activity. All products from the invested capital have a market value and that there is no product inventory required once the product is ready for sale (Balakrishnan et al, 2009). The analysts using CVP technique provides information about the products. The analyst also needs to know the levels of sales and volumes and the amount they need to protect the investment from making loses. The other information required by the analysts is the capacity for the analyst to determine the effects of increasing or decreasing the fixed costs. Successful analysts must have the capability of approximating the amount of funds required for expenditures and the magnitude of risks required (Balakrishnan et al, 2009). Profit equation using CVP analysis Analysts using CVP starts by determining the business profit using the profit equation as shown (Weygandt, 2009). Profit = Total revenue -Total costs Since the costs are in two divisions, i.e. fixed costs and variable costs, the equation becomes Profit =Total revenue -Total variable costs -Total fixed costs Profit is a function of the contribution margin. This refers to the amount of invested capital in this discussion (Balakrishnan et al, 2009). The total contribution margin is the difference between the total revenue and total variable costs. The calculation of contribution margin may also occur per unit production. This margin is necessary in consideration of the effects that volume has on a business profit. Realization of profits in a business takes place upon covering of sales equivalent to the fixed costs. This means that any unit sales above the fixed costs become profit. The overall profit equation in CVP analysis, therefore, becomes (Weygandt, 2009). Profit =P * Q - V * Q - F = (P - V) * Q – F Where; P _ Selling price per unit V _ Variable cost per unit (P _ V) _ Contribution margin per unit Q _ Quantity of product sold (units of goods or services) F _ Total fixed costs Cost-Volum e-Profit Graph (Weygandt, 2009) This is a graph that shows the bond amid the total income and total costs in a business. This graph also shows how profits change with time depending on different activity volumes. In the above graph, the loss decreases with increasing volume of sales. At the same time, there is an increase in the contribution margin. At the point, where the cost intersect with the revenue line, this point known as break-even point above which profits are evident. In the case, where there is income tax, the business after tax calculation makes use of the formula; After-tax profit = Pretax profit –Taxes. Pretax profit = (Tax rate -Pretax profit). Pretax profit = (1 - Tax rate). Snap Fitness business The principles of CVP are applicable in a number of business organizations, for example, in starting a snap fitness business. This small venture requires a small amount of capital to start. In addition, it takes a short time for the investor to reach a break-even