Breakeven Analysis and Cost Volume Profit - Myassignmenthelp.Com

Question: Discuss about the Breakeven Analysis and Cost Volume Profit. Answer: Every business is conducted with the motive of achieving some targets and objectives. Profit maximisation is one of the key objectives of the business in order to survive and grow smoothly. Profit is the important parameter of the overall success of the business. Hence, it must be pre-determined by any business using various analytical tools and techniques of management accounting. Few of those tools have been discussed below. Breakeven analysis is the important tool of management accounting that is used to determine the point of breakeven. Horngren (2009) clears that this analysis focuses on the relationship between the sales revenues and total costs of the business. Breakeven point is the level of activity which is achieved by any business when its total revenue from sales is exactly equal to its total expenses. It is the point where a firm neither earns any profit nor it incurs any loss from its operating activities. This point is also termed as point of equilibrium. It can be calculated in monetary terms as well as unitary terms. Business managers use breakeven point as the point of reference above which sales should be achieved to generate the profits for the firm. As per Hansen, Mowen Guan (2007) the analysis of breakeven is undertaken in two conditions which are discussed below: Linear cost and revenue relationship and the Non-linear cost and revenue relationship. On the basis of the above mentioned conditions, following are the methods of determining breakeven point for businesses and products: Graphical method: Although breakeven point for any products or business can be identified using equations but information can be communicated more effectively using visual formats. The pictorial presentation of the breakeven point helps the managers in understanding the immediate and clear results. Under graphical method, the relationship between sales revenue, cost and the volume is depicted. This method is used for linear breakeven analysis. Under this method price of the product is kept constant and the production of the company is expanded. Therefore, it shows the linearity between the total revenue of the business and its quantum of output. Algebraic Method: It is also known as equation method of calculating the breakeven point of sales which is represented by an equation that is based on formula for cost volume profit. P(x) = v(x) + FC + Profit Where, P= selling price per unit, X= number of units, V= variable cost per unit FC= total fixed cost. At the point of breakeven sales, the profit is zero and therefore the simplified CVP formula is used. Contribution analysis method: Under this method the additional or incremental sales revenue and costs related to it are analysed to determine the point of breakeven sales. Contribution is determined by deducting the total variable cost of the business (in case of firm dealing in single product) from the total revenue from the sale of the given product. This can also be determined by the graphical representation under which the line of total cost including both the fixed and variable cost is parallel to the variable cost. And at breakeven point both the lines of total revenue (which increases with the increase in level of output) and the total cost line are intersected by each other. The profit volume ratio: This is another method to identify the breakeven point for the product. It uses the formula to determine the point at which there is no profit and loss occurred in the business. Johnston (2017) confirmed that the formula for breakeven point can be used to identify the breakeven sales both in dollar terms and in terms of units. To determine the breakeven point in units the total fixed cost of the business (in case of a single product) or the allocated fixed cost to a particular product (in case of multiple products dealing) is divided with the contribution per unit. Contribution per unit is calculated by deducting the variable cost per unit from the selling price per unit. The resulted figure from the above calculation gives the breakeven sales units. According to Gutierrez Dalsted (1990) below the breakeven point the company will not be able to recover its total fixed cost and hence incur losses and above breakeven point the firm starts generating profits fr om that particular product. To calculate the breakeven point in terms of dollars the total fixed cost involved in the production of a particular product is divided with the contribution margin of that product. Contribution margin is determined by dividing the contribution per unit by the selling price per unit of the concerned product. The above discussed formulas are mathematically represented in the following manner: Breakeven Sales Calculation In Units= Total Fixed Cost (Bazley, Hancock Robinson, 2014). Contribution per Unit In Dollars= Total Fixed Cost (Cafferky, 2010). P/V Ratio Decision making is an important function that every business manager has to carry in the normal course of business. It involves selection of the best suitable alternative. Only quality decisions taken on correct time can contribute to achievement of desired goals and objectives of business. There are various tools that are being used by the managers of business to undertake the concrete decision making. According to Drury (2013) cost volume profitability analysis is one among those important and simplified tools used in management accounting as it supports the profit planning of the business. It basically analyses the relationship between the cost, volume and profit from a particular product dealt by the business. All the three factors are interconnected as well as dependent on each other (Horngren, Bhimani, Datar, Foster Horngren, 2002). These factors have direct influence on the firms profitability level. The cost volume profitability analysis is mainly aimed to assess the effect of change in the costs or prices or volume on the overall profitability. As per Wang, Li Zhang (2002) the study of CVP analysis is a comprehensive study and covers breakeven analysis as its part. The prime thrust of the management that remains for all the times throughout the business is to generate good profitability level and hence CVP analysis plays significant role in the profit planning of the firm. It also facilitates the cost control decision making. Profit cannot be attained in the business till the point of breakeven. Therefore, after breakeven point it is necessary to examine the shifts in the cost and the volume. For this purpose cost volume profitability analysis is considered. The CVP analysis allows the managers in analysing the potential impact of broad set of strategic decisions in the key areas such as pricing policies, market expansions or the change in product mixes etc., on the overall profitability of the business. The critical analysis of cost volume profitability of the business enables the managers of the firm to determine and set a desired level of profit to be target in the given period and to emphasize on its relationship with other income statement elements so as to determine the unknown. One of the common unknown element in such applications is the volume of sales that must be generated to achieve the desired level of profits. The major benefits of the CVP analysis can be derived by the managers in the areas like profit planning, decision making, price determination, cost control and in the preparation of budgets. For the planning of profits it is important to find the most profitable and suitable combination of selling price, volume and the cost. Therefore, by using CVP analysis managers can take appropriate and adequate measures to increase its profits by reducing the related costs of the particular activity. It therefore helps in assessing the firms margin of safety. Yuan (2009) argued that CVP analysis also supports the decision making process of managers when they have to determine the production mix, whether to produce the product or buy it from external market, selection of suitable distribution channel and the marketing strategy that must be used, choosing the appropriate pricing policy. CVP analysis also serves a base to determine the price of the product which the firm is dealing in by establishi ng the sensitivity of product prices to its sales volume. Since, CVP helps in evaluating the impact of cost on sales volume in order to review the firms profits and total costs incurred. To achieve the targeted profits, firms determine the desired sales level and hence prepare various flexible budgets which can indicate the estimated costs and expected revenues at different stages of production (Garrison, Noreen Brewer McGowan, 2010). From the above study, it can be concluded that, to achieve the desired results from the business managers must formulate such strategies and policies which can serve the purpose. The employment of various tools and techniques in the business operations can take the business to the next level. The advanced techniques of management accounting such as breakeven analysis, cost volume profitability analysis are the key analytical tools that helps the business in achieving the maximum profitability with the minimum cost. Hence, these techniques must be used by the managers in making the overall decisions for their businesses. References: Bazley, M., Hancock, P. Robinson, P., 2014. Contemporary accounting, Retrieved from https://books.google.co.in/books?id=KgepBQAAQBAJpg=PA543dq=break+even+analysis+pdfhl=ensa=Xved=0ahUKEwj4m-vl8tbXAhVJto8KHZuiB5IQ6AEIMTAC#v=onepageq=break%20even%20analysis%20pdff=false. Assessed on 02-01-2017. Cafferky, M. (2010).Breakeven Analysis: The definitive guide to cost-volume-profit analysis. Business Expert Press. DRURY, C. M. (2013).Management and cost accounting. Springer. Garrison, R. H., Noreen, E. W., Brewer, P. C., McGowan, A. (2010). Managerial accounting.Issues in Accounting Education,25(4), 792-793. Gutierrez, P. H., Dalsted, N. L. (1990).Break-even method of investment analysis. Colorado State University Cooperative Extension. Hansen, D., Mowen, M., Guan, L. (2007).Cost management: accounting and control. Cengage Learning. Horngren, C. T. (2009).Cost accounting: A managerial emphasis, 13/e. Pearson Education India. Horngren, C. T., Bhimani, A., Datar, S. M., Foster, G., Horngren, C. T. (2002).Management and cost accounting. Harlow: Financial Times/Prentice Hall. Johnston, K. (2017), How to Calculate Break-even Point for Products. Retrieved from: https://smallbusiness.chron.com/calculate-breakeven-point-products-59448.html Accessed on: 02-01-2017. Wang, F. S., Li, H. L., Zhang, Y. (2002). Cost-volume-profit Analysis Method Based on Activity-Based Costing [J].China Soft Science,8, 022. Yuan, F. C. (2009). The use of a fuzzy logic-based system in cost-volume-profit analysis under uncertainty.Expert Systems with Applications,36(2), 1155-1163.