This is a short article that will walk you through the objectives of CVP analysis and some common assumptions revolving around the process.
Let’s try to understand the core objectives of cost-volume-profit (CVP) or break-even (BE) analysis followed by some assumptions underlying these objectives.
Cost-volume-profit or break-even analysis objectives
- To forecast profits: helps to identify profit relationships, costs and volumes for determining relative profitability and to compare inter-company profitability
- To set budgets: is useful in setting up flexible budgets that indicate costs at different activity levels
- To evaluate performance: helps performance evaluation by focusing on profits achieved and costs incurred
- To set pricing: plays an important part in stabilising volume. BE analysis helps organisations to formulate pricing policies
- To determine overheads: helps to determine the number of overheads that should be allocated to product costs at different levels of operation
- To achieve capacity: focuses on the importance of achieving capacity to achieve economy.
Assumptions
Here are some assumptions about the use of CVP analysis in business.
- CVP analysis costs can be segregated into fixed and variable portions and total fixed costs remain constant at all output levels.
- In CVP, cost linearity is preserved over the relevant range, and revenues are constant per unit.
- A business has a constant product mix and produces only one kind of product.
An efficient manager or business owner tries to bring out the best results from cost-volume-profit analysis, while steering clear of assumptions.
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Financial Analysis for Business Performance: Reporting and Stakeholder Management
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Which of the following is not an assumption underlying cost-volume-profit analysis?
a.The break-even point will be passed during the period.
b.Total sales and total costs can be represented by straight lines.
c.Costs can be accurately divided into fixed and variable components.
d.The sales mix is constant.
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