Sale & Profit costing
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.
- Variable costs per unit are constant.
- Total fixed costs are constant.
- Everything produced is sold.
- Costs are only affected because activity changes.
- If a company sells more than one product, they are sold in the same mix.
In economics, cost analysis refers to a measure of the cost-output connection, i.e. economists are interested with estimating the cost of employing inputs and how effectively they may be rearranged to raise the firm’s productivity (output).
In other words, cost analysis is concerned with evaluating the money worth of inputs (labor, raw materials), also known as the total cost of production, which aids in identifying the optimal level of output.
There are various cost ideas related to company operations and choices, which may be classified into two overlapping categories for ease of comprehension.
Cost Concepts Used for Accounting: Generally, accountants utilize these cost ideas to analyze the firm’s financial status. They are in charge of managing the firm’s finances and hence maintain track of its assets and obligations. Accounting expenses are utilized for tax reasons and to calculate the firm’s profit and loss. They are:In economics, cost analysis refers to a measure of the cost-output connection, i.e. economists are interested with estimating the cost of employing inputs and how effectively they may be rearranged to raise the firm’s productivity (output).
In other words, cost analysis is concerned with evaluating the money worth of inputs (labor, raw materials), also known as the total cost of production, which aids in identifying the optimal level of output.
There are various cost ideas related to company operations and choices, which may be classified into two overlapping categories for ease of comprehension.
Cost Concepts Used for Accounting: Generally, accountants utilize these cost ideas to analyze the firm’s financial status. They are in charge of managing the firm’s finances and hence maintain track of its assets and obligations. Accounting expenses are utilized for tax reasons and to calculate the firm’s profit and loss. They are:
- Opportunity Cost
- Business Cost
- Full Cost
- Explicit Cost
- Implicit Cost
- Out-of-Pocket Cost
- Book Cost
Analytical Cost Concepts Used for Economic Analysis of Business Activities: These cost concepts are used by the economists to analyze the likely cost of production in the future. They are concerned with how the cost of production can be managed or how the input and output can be re-arranged such that the overall profitability of the firm gets improved. These costs are:
- Fixed Cost
- Variable Cost
- Total Cost
- Average Cost
- Marginal Cost
- Short-run Cost
- Long-Run Cost
- Incremental Cost
- Sunk Cost
- Historical Cost
- Replacement Cost
- Private Cost
- Social Cost
In business, the manager must have a thorough grasp of the cost-output relationship since it aids in cost management, marketing, pricing, profit, production, and so on. The cost-output relationship is written as C = f (S, O, P, T), with C representing cost, S representing firm size, O representing output, P representing price, and T representing technology.
As the firm’s size grows, economies of scale expand, lowering the cost of per unit manufacturing. The cost and output are positively related; as the output grows, so does the cost, and vice versa. Similarly, the price of inputs is directly proportional to the price; when input prices rise, so do manufacturing costs. However, technology is inversely connected to cost, which means that as technology improves, manufacturing costs fall.
Thus, cost analysis is critical in business decision-making since the costs associated with input and output must be well understood before establishing the firm’s production capacity.
The Importance of Cost Volume Profit Analysis
CVP analysis aids in establishing the level at which all relevant costs are recovered while there is no profit or loss, commonly known as the breakeven point. It is the moment at which sales volume equals total costs (fixed and variable). Thus, CVP analysis assists decision-makers in understanding the impact of changes in sales volume, pricing, and variable cost on an entity’s profit while treating fixed costs as unchangeable.
CVP Analysis assists in understanding the link between profits and expenses on the one hand, and volume on the other. CVP Analysis is effective for creating flexible budgets that reflect expenses at different levels of activity. CVP Analysis is also useful when a firm is seeking to establish the volume of sales needed to obtain a specific revenue..