INITIAL INSTRUCTIONS: 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.
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.
****FOR THIS ASSIGNMENT!*** PEER RESPONSE INSTRUCTIONS: It is important that you become comfortable receiving and giving constructive criticisms, since this is an important component in one’s professional growth and development and a core competency for leaders.
Also important is that your peer responses be reflective and instructive to you. Students should ‘reflect’ on their peer responses before entering your peer post.
Students will be expected to read and reflect on the initial posting of at least TWO peers, and then provide thoughtful comments addressing the following:
- Point out what you perceived to be the strengths of the initial posting along with supporting rationale.
- Identify specific opportunities for improvement with regard to the content in the initial posting. Furthermore, you should provide supporting rationale for your stated position, as well as concrete suggestions and guidance intended to strengthen the effectiveness of the content.
PEER RESPONSE 1(Adam)
When analyzing a company’s financial documents, one of the staples for net income is fixed cost. Fixed costs are expenses that that do not fluctuate with changes (Wann, 2023). Some common fixed expenses that most companies have are rent, salaries, insurance, etc. Using fixed costs along with variable costs helps an organization plan out their financials for the year.
Firstly, while it is true that some fixed costs can become variable costs over time, it is not practical to assume that all fixed costs can be unfixed (Tamplin, 2023). For example, the lease payments for a building are typically considered fixed costs as they remain constant over the term of the lease. However, if the lease agreement allows for subletting or early termination, the lease costs can become variable. However, this is not the case for all fixed costs. Therefore, it is important to distinguish between fixed and variable costs in CVP analysis to make effective decisions.
Secondly, while gross margin is an important metric for a company, contribution margin is equally important, if not more so, in CVP analysis. Gross margin only considers the cost of goods sold, whereas contribution margin considers all variable costs associated with the production and sale of a product. This makes the contribution margin a more useful metric in determining the profitability of a product or service and in making decisions about pricing and cost structure.
Finally, it is possible to perform CVP analysis for a company that produces multiple products by calculating the weighted average contribution margin for all products. This allows managers to make decisions about the overall profitability of the company and to allocate resources appropriately. Without fixed costs, CVP analysis gets skewed because there is calculations like manufacturing overhead that cannot be calculated as easy without fixed cost.
It is important for Mr. Adrian to understand the importance of fixed and variable costs in CVP analysis, the significance of contribution margin, and the ability to perform CVP analysis for a company that produces multiple products. It is recommended that Oslow Company provide Mr. Adrian with additional information and training on these topics to ensure that all members of the company have a thorough understanding of CVP analysis and its applications.
PEER RESPONSE 2
I would agree with Mr. Adrian’s recommendation. Over time variable costs would be more important whereas fixed costs are only significant over time. Utilizing the concept of marginal analysis in cost management, the contribution margin volume profit ratio, break-even analysis, and margin of safety play a considerable role.
Cost volume profit helps managers determine which products to offer, price to charge for the products, strategies for marketing, and cost structure. Managers use break-even and target profit analysis to determine how much must be produced to avoid a loss or to earn a profit. The break-even point is the point at which all sales result in no profit and no loss. The margin of safety is the excess of actual sales over the break-even sales. (Garrison, pgs 194-196)
Our textbook tells us the contribution format income statement can be expressed in equation as “Profit = (Sales – Variable expenses) – Fixed expenses.” (Garrison, pg.195) The information provided in this week’s discussion post; Sales is $20,000, Variable expenses is $12,000, Fixed expenses is $6,000, and Net operating income is $2,000. If you utilize the above formula to determine profit ($20,000 – $12,000) – $6,000 = $2,000, profit is net operating income.
Break-even analysis equation method “Profit = Unit CM x Q – Fixed expense. Using this equation; Profit is $2,000, Unit CM is $8,000, Fixed expenses is $6,000, Profit volume ratio is 40% (Contribution / Sales) * 100. The break-even point would be a sales volume of $15,000.
Margin of Safety formula “Margin of safety in dollars = Total budgeted/actual sales – Break-even sales.” Utilizing this formula; Actual sales is $20,000, Break-even sales is $15,000. The margin of safety would be $5,000.
