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Cost-Volume-Profit (CVP) analysis is a very useful tool for us as managers to understand the relationship among cost-volume-profit and then forecast profit at various levels of output. This analysis focuses to factors that affect profit, including selling prices, sales volume, unit variable costs, total fixed cost, and mix of products sold.
The Good Side
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Decision Making | In business there are some problem emerged, such as product selection mix, make or buy decisions, selection of the best channel of distribution or the type of marketing strategy to use which will require manager to choose the best option for solving the problem. This analysis will be the vital tool for decision-making process to increase profitability. |
Profit Planning | In business, we always face a lot of combination of elements to be considered for sales and sometimes it is confusing. This profit planning feature from CVP analysis can be used to assist in finding the most profitable combination between selling price, cost and volume, which makes calculations of expected profit at different sales levels in easier way. Also, managers can measure the break even point and the margin of safety assessment. |
Price Determination | CVP analysis serves as a basis for price determination. For example: in a dental industry where a competitor sets the price of a service at Rp 100.000,00 (let’s say nano-composite tooth filling) and the business is actually can’t go below Rp 250.000,00, it's the turning point to analyze the options we should choose. We should analyze fixed and variable cost to reduce the price of the service mentioned before at Rp 100.000,00 or even remove one of those two costs at all. |
Cost Control | CVP analysis helps in evaluating the effects of cost volume changes, in order to review expected profit because certain costs incurred. For example: a dental clinic may want to purchase CAD/CAM dental machine so the time required for dental technician laboratory can be cut, therefore patients’ satisfaction can be improved. The new machine mentioned before obviously can increase fixed costs. At this point, the dental clinic should use CVP analysis to choose variable cost can be decreased in order to achieve the same profit level. |
Preparation of Budgets | CVP analysis can also determine the levels of sales to be achieved to meet their targeted profit. The managers the will prepare the budgets consist of the costs and the expected revenues at any level of production. |
The Bad Side
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Required So Much Detail | CVP analysis allows the manager to consider many variable costs for future development or project, with various statistical models of possibilities. However, this also can be a disadvantage to managers who are not detail-oriented and precise with the data they find and take notes, which leads to an inaccurate projections. |
Limitations | Other than benefits CVP analysis has, actually it is limited in the amount of information it can provide in a multi-product operation. This analysis is more often used by managers for a single product. For example (taken from “Advantages & Disadvantages of Cost-Volume-Profit Analysis” written by Jared Lewis) Northern Arizona University notes that multi-product businesses, such as restaurants, can have a difficult time with CVP analysis because menu items, for instance, are likely to have many variable cost ratios. Therefore, it is more likely a challenge for us, as busines manager, to modify the CVP analysis to be more adaptive with this certain situation. |
Conclusion
Despite the fact that CVP analysis still has some disadvantages,this analysis is the best method so far to forecast profit at various levels of output, especially for specific product/service.
Author: Muhammad Sulaiman Kusumah Adiwirya
Reference:
1. Garrison, RH., et al. 2011. Managerial Accounting: an Asian Perspective. Singapore: McGraw-Hill.
2. Lewis, J. Advantages & Disadvantages of Cost-Volume-Profit Analysis. Retrieved 14 Mar 2013 from http://smallbusiness.chron.com/advantages-disadvantages-costvolumeprofit-analysis-35135.html
3. Wicks, D. The Benefits of Analyzing Cost-Volume-Profit. Retrieved 14 Mar 2013 from http://www.ehow.com/info_8428943_benefits-analyzing-costvolumeprofit.html
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