In any company it is extremely apparent for concerns like, what effect on profit can it expect if it produces more products? What quantity of items and services must a business sell in order to recover cost for the year? What occurs to the breakeven point of the organisation if it chooses to include or increase the amount of a product and services they currently offer? to occur. The analytical strategy that helps the managerial accounting professionals to address these concerns is called Expense Volume revenue analysis.
(Tata McGraw-Hill, 2008 p. 298). It offers with vital details about the impact of income raised and the cost incurred within a certain service. CVP analysis can also be used to analyse the result on profit due to changes in costs, costs, tax, interests and the mix of item offered by the organisation. (Tata McGraw-Hill, 2008 p. 298).
CVP analysis is used by the managers in day to day basis in order to run the organisation smoothly. Correct use of this can lead to an in-depth understanding of what actions should and can be taken in order to save the business from dealing with any loss, and make earnings or a minimum of break even.
CVP analysis is a practical tool for the management however it likewise suffers with some limitations. It offers the management with the insight of the current position of business and also reflects any prospective issues the business might face in a brief run. CVP graph directs management’s attention to this circumstance but is unable to supply a solution to any prospective problem within business.
(Tata McGraw-Hill, 2008 p. 303).
Many assumptions should be made in order to produce a CVP analysis such as, keeping the total revenue linear which means the price or product or service will not change as sales changes, keeping total expense linear which means the total fixed and the unit variable expense remains unchanged as activity varies, the efficiency and productivity remains constant and the sales mix in a multi products company remains constant. (Tata McGraw-Hill, 2008 p.314). All these assumptions are very much necessary in order to produce a CVP analysis but they are not necessarily constants in a day to day business. If by any reasons the sales mix changes in the business than a new CVP analysis should be made for this new sales mix. CVP analysis provides the management of any organisation with vital information that it requires for day to day operation but also has some limitations.
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