Benefitsof Using CVP Analysis
Benefitsof Using CVP Analysis
Accordingto Cafferky & Wentworth (2014), cost-Volume-Profit (CVP) is amanagerial accounting tool that considers how costs of a product andthe sales volume affect the operating profit of business. It isconcerned with how changes in the sales mix of two products, sellingprice per unit, fixed costs, and variable costs affect the operatingprofit. CVP assumes that all produced units are sold, total fixedcost, variable cost and selling price are constant (Cafferky& Wentworth, 2015).For any business, several factors affect the profit it obtains. Thetwo dominant factors include the costs used in the manufacturingprocess and the sales volume (Jiambalvo, 2016). The management cannotaffect and control the market forces. Hence, to obtain the projectedamount of profits, the organization’s management has to monitor thevarying costs incurred by the business. This occurs since fixed costsare constant and uncontrollable. Hence, they cannot apply to decisionmaking. Notably, it affects the investment plan to acquire an$850,000 manufacturing equipment at Diamond Dynamics Company.Therefore, CVP is beneficial since it aids in decision making processconcerning the purchase of a manufacturing equipment, thedetermination of cost of products, and calculation of projected salesafter the purchase of the equipment.
Cost-Volume-Profitanalysis can be useful in the determination of whether an investmentis worth the cost or not. First, using this method of analysis willfacilitate the decision making process on whether to purchase theequipment or forfeit the proposal (Jiambalvo, 2016). The decisionwill consider whether the investment will result in profit. If thereis the realization of an estimated profit, then it is worth buying.
Second,CVP is a basis for determining the price of manufactured commodities.For instance, the product that is to be produced by the proposedmachine should be sold at a price that will enable the business torealize profits. The selling price should be such that customers willstill have the capacity to purchase the products (Jiambalvo, 2016).Besides, the profits to be made should cover the cost of theinvestment. Otherwise, the purchase of the new manufacturingequipment may not be worth the cost. Furthermore, CVP can enableDiamond Dynamics to control the costs. Essentially, they candetermine the changes in cost volume. The reason for this is to havea review of the profits since there would be incurred costs.Acquiring such an expensive equipment increases the fixed costs.Therefore, CVP analysis should be applied to determine the reduciblevariable costs to achieve similar profits.
Lastly,CVP analysis will identify the number of sales that the prospectedmachine would offer (Cafferky & Wentworth, 2015). The level ofsales should meet the targeted sales. If the estimated profits arerealized, then it is worth buying the new equipment.
Inconclusion, CVP analysis method has several benefits includingfast-tracking the decision making process regarding the purchase, thedetermination of cost of products after the acquisition of theequipment, and calculation of projected sales after the procurementof the equipment. However, this method is limited as it assumes thatunit variable costs and unit variable costs are constant. Therefore,it cannot be used for extended accounting which considers a product’sentire life cycle. In such cases, throughput accounting (TA) oractivity-based accounting is preferable.
Cafferky,M. E., & Wentworth, J. (2014). Breakevenanalysis: the definitive guide to cost-volume-profit analysis.New York: Business Expert Press.
Cafferky,M., & Wentworth, J. (2015). Breakeven Analysis: The DefinitiveGuide to Cost-Volume-Profit Analysis. doi:10.4128/9781606490174
Jiambalvo,J. (2016). Managerialaccounting.Hoboken, NJ: Wiley.