Cost–Volume–Profit Analysis
27 May 2013
To: Board of Directors, WotsyWot Pty Ltd (the ‘Company’)
Attention: Mr ABC, Chief Executive Officer
Scope
We have been engaged by the management of the Company to appraise the possibility of business expansion for the Company. In order to initiate the appraisal process, we have been provided with current demand, current operating capacity, fixed costs, variable costs and other ancillary information. It was also brought to our attention that presently the Company is catering the demand of its product W within a local community. However the Company wishes to analyse the implications if a decision is made in respect of launching product W at the state level. As a consulting firm, we will perform a cost-volume-profit [CVP] analysis whereby we will examine where the Company stands now and where the Company intends to be. CVP analysis is extension of break-even analysis – a situation where a business earns no income and incurs no loss. From the analysis we shall then deduce results and make recommendations.
Theoretical Background
In order to carry out a CVP analysis, we need to have an understanding of its mechanism. As noted before, CVP analysis is based on break-even analysis. Break-even analysis deals with the identification of break-even point (Cafferky & Wentworth, 2010) where revenues and costs are equal and thus the business is neither generating income nor incurring loss. Therefore, at break-even point we can say that:
Total Revenue = Total Cost
But total cost is in turn made of fixed and variable costs:
Total Revenue = Fixed Cost + Variable Cost
However revenue and variable costs are based on quantities [Q] demanded and produced. Therefore we can update the ongoing equation as follows:
Q x Sale Price = Fixed Cost + (Variable Cost x Q)
From above equation, we can work out break even units as follows:
Q = Fixed Cost / (Sale Price per Unit – Variable Cost per Unit)
The above mathematical equations (Besley & Brigham, 2008) can be used to
To: Board of Directors, WotsyWot Pty Ltd (the ‘Company’)
Attention: Mr ABC, Chief Executive Officer
Scope
We have been engaged by the management of the Company to appraise the possibility of business expansion for the Company. In order to initiate the appraisal process, we have been provided with current demand, current operating capacity, fixed costs, variable costs and other ancillary information. It was also brought to our attention that presently the Company is catering the demand of its product W within a local community. However the Company wishes to analyse the implications if a decision is made in respect of launching product W at the state level. As a consulting firm, we will perform a cost-volume-profit [CVP] analysis whereby we will examine where the Company stands now and where the Company intends to be. CVP analysis is extension of break-even analysis – a situation where a business earns no income and incurs no loss. From the analysis we shall then deduce results and make recommendations.
Theoretical Background
In order to carry out a CVP analysis, we need to have an understanding of its mechanism. As noted before, CVP analysis is based on break-even analysis. Break-even analysis deals with the identification of break-even point (Cafferky & Wentworth, 2010) where revenues and costs are equal and thus the business is neither generating income nor incurring loss. Therefore, at break-even point we can say that:
Total Revenue = Total Cost
But total cost is in turn made of fixed and variable costs:
Total Revenue = Fixed Cost + Variable Cost
However revenue and variable costs are based on quantities [Q] demanded and produced. Therefore we can update the ongoing equation as follows:
Q x Sale Price = Fixed Cost + (Variable Cost x Q)
From above equation, we can work out break even units as follows:
Q = Fixed Cost / (Sale Price per Unit – Variable Cost per Unit)
The above mathematical equations (Besley & Brigham, 2008) can be used to
Bibliography: Besley, S., & Brigham, E. F. (2008). Essentials of Managerial Finance. The United States of America: Cengage Learning. Cafferky, M., & Wentworth, J. (2010). Breakeven Analysis: The Definitive Guide to Cost-Volume-Profit Analysis. The United States of America: Business Expert Press. Rajasekaran, V. (2010). Cost Accounting. India: Pearson Education India. Schweitzer, M., Trossmann, E., & Lawson, G. H. (1992). Break-even Analyses: Basic Model, Variants, Extensions. The United States of America: John Wiley & Sons.