Cost-volume-profit (CVP) analysis allows managers to see how changes in costs and volume will affect the company’s operating expenses and net income (for-profit) or net assets (non-profit). This form of analysis compares different relationships, such as the cost of operating and producing goods and services, the volume of goods and services sold, and the profits generated from the sale of those goods and services. Cost-volume-profit (CVP) analysis helps managers make rational decisions such as what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to maintain. Its primary purpose is to estimate how profits are affected by the following five factors: selling prices, sales volume, unit variable costs, and total fixed costs. The CVP analysis is also extremely helpful in determining the contribution margin (CM), which is the per-unit revenue from the sale of goods and services minus the per-unit variable costs (VC) associated with producing the goods or delivering the services, with the product being the amount remaining to cover the fixed costs (FC) and ultimately flows into the profits. We, as industry leaders, need to understand those variables that impact profit maximization, and then make changes, as necessary, to improve our firm’s financial position. The CVP model is one example of managerial accounting approach intended to aid managers in making smart financial and operational decisions.
Oslow Company prepared the following contribution format income statement based on a sales volume of 2,000 units (the relevant range of production is 500 units to 1,500 units).
Sales $20,000
Variable Expenses 12,000
Contribution Margin 8,000
Fixed Expenses 6,000
Net Operating Income $ 2,000
One member of Oslow Company (Mr. Adrian) has challenged the fixed expenses. Mr. Adrian says “There is no such thing as a fixed cost. All costs can be unfixed given sufficient time.” Mr. Adrian also has made the comment that gross margin is more significant than contribution margin. And he states that since Oslow Company produces multiple products, CVP analysis cannot be computed. Mr. Adrian has been vocal with his thoughts throughout the production departments of Oslow Company.
Initial Post Directions
Oslow has never utilized CVP methodologies before. You are the new CFO for Oslow Company. How would you convince Mr. Adrian and other executive-level staff that CVP analysis would benefit Oslow Company?
In order to formulate your recommendation, you may want to carefully consider the problem, the three (3) CVP assumptions, collect relevant data and information, critically evaluate the alternatives, and document your recommendations using sound arguments that are well supported, properly vetted, and logically presented.
