Paper Topic:

Cost-Volume-Profit (CVP) Analysis

5 Introduction - Uses of break-even analysis

Break-even analysis , also known as cost-volume-profit analysis is a technique that examines the effect of changes in sales volume , prices and costs on the profits of the firm . Cost-volume-profit analysis is particularly useful to assist in economic decision-making . It helps management in making decisions by providing information about

The break-even point

The optimal level of production

Which products or services to prioritise

Budgeted value for discretionary expenditure

Cost-volume-profit analyses also assist managers in planning , monitoring and controlling the operations of the enterprise p

All the aforementioned benefits will be illustrated and explained in the next sections

5 .1 Calculation of the break-even point

The break-even point is the point where the or service is equal to the neither making a profit nor a loss

An important assumption behind cost-volume-profit analysis that should be stressed in to determine the break-even point is the separation of costs consist of costs , which are not affected by changes in the volume of production . Fixed costs are incurred even if there is no production Typical examples of fixed costs consist of factory rent , interest on loans and more

Variable costs are costs that vary in direct proportion with the units produced . Therefore the higher the production level , the more the variable costs . Examples of variable costs are direct materials used in production and direct labour employed in the production process

In cost-volume-profit analysis it is important that we examine properly the cost behaviour in to be able to determine the break-even point and the margin of safety . This point will be further highlighted in the next sub-section when we show how to draw a break-even chart

5 .1 .1 Graphical approach of the break-even chart

The break-even point may be determined either with the use of formulas or via a graphical approach . Due to the advantage that a graph is more easily understood than a formulae , we are going to utilise the graphical approach . The following hypothetical example will be used to further illustrate the calculation of the break-even point and margin of safety

A company is involved in the production of widgets . During February 2008 the company operated at 80 capacity and produced and sold 30 ,000 widgets . The costs incurred during this month are the following

Direct material cost ?1 per widget

Direct labour cost ?2 per widget

Fixed costs ?50 ,000

The selling of widgets is ?5 per widget

We will start by examining the type of costs and distinguishing between fixed and variable costs . The variable costs are direct materials and direct labour . Therefore the per widget ?1 ?2 . We can now depict the information in the following graph

The following principles has been utilised in to draw Figure 5 .1

The independent variable , which is the output of widgets have been drawn on the x-axes , while the costs and sales value were depicted on the y-axes in accordance with the general principles of drawing graphs

The fixed costs of ?50 ,000 are...

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