Finance Discussion Post

Cost-volume-profit(CVP) analysis is a method of cost accounting that helps a business tofigure out how the changes in variable and fixed costs impact acompany’s profit. Based on a CVP analysis, a company can determine howmany units they need to sell to reach a minimum profit margin or breakeven (to cover all expenditures). Understanding the relationship betweencost, the volume of activity and profit helps a manager to assess riskand make informed decisions (McLaney & Atrill, 2023) relating toproducts/services, selling price, marketing strategy, cost structure,etc.Apartfrom the useful insights of CVP analysis into how these aspectsinteracts with one another to allow managers to make rational decisionsto increase profitability, there are several assumptions about costbehavior of CVP and limitations of CVP that need to be taken intoconsideration.Thefirst assumption is that all costs can be defined and segregated intotwo categories: fixed costs (renting, insurance, staff salaries…) andvariable costs (raw materials, the power used for machinery, etc.)(Tamplin, 2023). This assumption is not always true because certaincosts (e.g., depreciation) cannot be determined exactly; anddifferent methods of depreciation may yield different results. Apartfrom the 2 categories of cost mentioned earlier, there’s the third oneknows as semi-variable costs (mixed costs) that are partly fixed, andpartly variables (E.g electricity, telephone expenses).Anotherassumption is that selling prices don’t vary, and the fixed costs stayunchanged. The price of a product or service will not change as volumechanges. As noted by MacLaney & Atrill (2023, p.340), “variable costwill be the same per unit of activity, irrespective of the volume ofactivity”. What’s more, in a CVP analysis, total sales and total costsare assumed to be linear and can be represented by straight lines.However, in practice this assumption is not always true. For example, ifa business firm sells more units, the variable costs per unit maydecrease due to more operating efficiencies in the factory (Agarwal,n.d)

Question:

CVPanalysis has many limitations, how can managers optimize the techniqueas a part of their budgeting and managerial planning process?