# Discuss the important of cost-volume-profit analysis business planning and decision making

Cost-volume-profit analysis is a tool that can be utilized by business managers to make better business decisions. To do an effective job in planning and decision-making, management must have analyses which allow reasonably correct predictions of how profits will be affected by a change in any one of these factors.

Also, management needs an understanding of how revenues, costs and volume interact in providing profits. All these analyses and information are provided by cost-volume-profit analysis. Cost-Volume-Profit CVP analysis is a systematic method of examining the relationships between selling prices, total sales revenue, and volume of production, expenses and profit.

Such information can help management improve the relationship between these variables. Limitations of CVP Analysis: CVP analysis is a useful planning and decision-making device, usually in the form of a chart, showing how revenue, costs, and profit fluctuate with volume.

Budgeting makes use of CVP to forecast profits. Further, CVP is used to evaluate the profit impact of alternative decisions. In spite of CVP being a useful technique, it suffers from some of the following limitations: Because of the many assumptions, CVP is only an approximation at best.

CVP analysis needs estimates and approximation in assembling necessary data and thus lacks accuracy and precision. In CVP analysis, it is assumed that total sales and total costs are linear and can be represented by straight lines.

In some cases, this assumption may not be found true. For instance, if a business firm sells more units, the variable costs per unit may decrease due to more operating efficiencies in the factory.

Definition of CVP Analysis: Cost-Volume-Profit (CVP) analysis is an important tool that provides management with useful information for managerial planning and decision-making. Profits of a business firm are the result of interaction of many factors. In cost-volume-profit analysis –or CVP analysis, for short – we are looking at the effect of three variables on one variable: Profit. CVP analysis estimates how much changes in a company's costs, both fixed and variable, sales volume, and price, affect a . Importance of Cost Volume Profit (CVP) Analysis: The most profitable combination of variable cost, fixed cost, selling price and sales volume can be found with the help of cost volume profit analysis.

CVP analysis is performed within a relevant range of operating activity and it is assumed that productivity and efficiency of operations will remain constant. This assumption may not be valid. CVP analysis assumes that costs can be accurately divided into fixed and variable categories.

Such categorization is sometimes difficult in practice.

## BREAKING DOWN 'Cost-Volume Profit Analysis'

CVP analysis assumes no change in the inventory quantities, during the period. That is, opening inventory units equal the closing inventory units.

When changes take place in inventory level, CVP analysis becomes more complex. If prices, unit costs, sales-mix, operating efficiency, or other relevant factors change, then the overall CVP analysis and relationships also must be modified.

Because of these assumptions, cost data are of limited significance. Furthermore, a number of problems arise while making a multi-product analysis under CVP analysis. The first problem is identifying the facilities which are shared by unrelated products. If fixed expenses and facility usages can be identified directly with individual products, the analysis will be satisfactory.

A second problem occurs if there is a non-linear relationship in the units of measurement.

## Cost-Volume-Profit Analysis

Different products typically yield different contribution margins and are produced in various volumes with differing costs. As a result neither the revenue curve nor the cost curve is necessarily straight and the break-even point is difficult to find.

A third problem lies in the assumption of certainty in demand projections. Most analyses performed by accountants and managers are deterministic, certainty is assumed although uncertainty is the environment of operation. A fourth problem is the complexity of analysis where several products are concerned.

The maker of revenue and cost curves for each product plotted on the conventional break-even group results generally in a meaningless hodgepodge. A series of CVP analysis, based on different sets of assumptions and circumstances may be prepared to reflect situations prevailing in different business enterprises.

When circumstances change, CVP analysis should also be revised to reflect the changing situations. It is also necessary to have up-to-date analysis so that it can act as a useful device in profit forecast, budgeting, cost control and managerial decision-making.Jaedicke and Robichek () explain cost-volume-profit analysis being useful to determine the optimal level and mixes of output to be produced with available resources, i.e.

in making the firm's short-run output decision. In cost-volume-profit analysis –or CVP analysis, for short – we are looking at the effect of three variables on one variable: Profit. CVP analysis estimates how much changes in a company's costs, both fixed and variable, sales volume, and price, affect a .

Cost-volume-profit (CVP) analysis. is used to determine how changes in costs and volume affect a company's operating income and net income.. In performing this analysis, there are several assumptions made, including: Sales price per unit is constant.

Analyzing Cost-Volume-Profit Relationships 1 Understand the key factors involved in cost- analysis is used to make important planning deci-sions concerning appropriate levels of production such an important tool in management decision making.

Jun 27,  · Cost-volume-profit analysis is a tool that can be utilized by business managers to make better business decisions.

Cost-volume-profit (CVP) analysis. is used to determine how changes in costs and volume affect a company's operating income and net income.. In performing this analysis, there are several assumptions made, including: Sales price per unit is constant.

Importance of Cost Volume Profit (CVP) Analysis - timberdesignmag.com