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Cost-Volume-Profit Graph
"In management accounting, Cost-Volume-Profit Analysis (CVP) is a form of cost accounting. It is a simplified model, useful for elementary instruction and for short-run decisions. COST-VOLUME-PROFIT ANALYSIS Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven analysis." - wikipedia
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Introduction
A Cost-Volume-Profit graph (CVP) illustrates the relationships among
- Activity volume
- Total revenues
- Total costs
- Profits
It shows the break-even point by depicting revenue, cost, and profit relationships over a range of activity. This representation allows one to view the relative amount of important variables at any graphed volume.
Profits are represented by the difference between total revenues and total costs. As unit sales increase, the contribution margin first goes to cover the fixed costs. Beyond the break-even point, any additional contribution margin provides a profit.
When management is primarily interested in the impact of changes in sales volume on profits and less interested in the related revenues and costs, a profit-volume graph is sometimes used.
Advantages of Break Even Chart
- It is the simple presentation of cost, volume and profit structure of the company.
- Each significance can be seen at a glance.
- It is useful for
- Studying the relationship of cost, volume and profit as it shows the effect on profits of changes in fixed costs, variable costs, selling price and volume of sales.
- Forecasting costs and profits of various volumes of sales.
- It is a tool for cost control as it shows the relative importance of the fixed cost and the variable cost.
- Profitability of various products can be studied and a most profitable product mix can be adopted.
- Profits at different levels of activity can be ascertained.
The profit potentialities can be judged from the study of the position of the break-even point and the angle of incidence.
Assumptions underlying Break-Even Chart
- All costs can be separated into fixed and variable costs.
- Fixed costs will remain constant and will not change with the change in level of output.
- Variable costs will fluctuate in the same proportion in which the volume of output varies. Prices of variable cost factors i.e. wage rate, price of material etc. will remain unchanged.
- Selling price will remain constant even though there may be competition or change in volume of production.
- The number of units produced and sold will be the same so that there is no opening or closing stock.
- There will be no change in operating efficiency.
- There is only one product or in the case of many products, product mix will remain unchanged.
How to read Break Even Chart
- Low break-even point and large angle of incidence in the break even chart indicate -
- Fixed costs are low and margin of safety is high.
- It is a sign of financial stability.
- In such a case, some monopolistic conditions prevail and high profits are earned over a large range of production activity.
- Low break-even point and small angle of incidence show -
- Fixed costs are low and margin of safety is high.
- But rate of profit is not high because of absence of monopolistic conditions.
- High break-even point and large angle of incidence show -
- Fixed costs are high and margin of safety is low.
- A small fall in volume may put the business into losses and a small increase in volume may give a high profit because of large angle of incidence.
- High break-even point and small angle of incidence is -
- The worst position, because it indicates a low margin of safety and a low rate of profit.
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