In an organization, the cost-volume-profit (CVP) analysis is undertaken in order to determine how the changes in the entitys costs and volume, affect its operating and net income (Shim and Siegel, 2009). Additionally, the CVP analysis aids an organization to determine its contribution margin. In this case, the margin is the total amount that remains from the sales revenue after the deduction of the variable expenses. Additionally, an entity then uses the amount that remains to initially cover all its fixed costs and then considers all thats left afterward to be the profit. Nevertheless, when performing the CVP analysis, several factors are considered.
The analysis assumes that the sales price per unit, variable cost per unit and total fixed costs remain constant. Additionally, it is also assumed that everything produced by the organization is sold and any costs incurred are only affected by activity changes. This report will focus on CVP analysis by providing a differentiation between an economists and account breakeven charts. The report will also offer a discussion of the cost relevant range and cost period of time aspects of fixed costs in an organization. Ultimately, the report will offer a differentiation between the breakeven point and margin of safety.
Economists and Accountants Breakeven Charts
Economist Breakeven Charts
It is a line graph that is employed to formulate an estimation of the point at which the total sales revenue becomes equal to the total costs. In this case, it is the point at which the loss ends in an organization and the profits realized begins to accumulate. Furthermore, it can also be characterized as a graph that portrays how fixed, variable and total costs as well as total revenue changes with the volume or scale of output. Additionally, the economist breakeven chart is employed to calculate the breakeven point.
In a business organization, it is essential for an entrepreneur to realize his/her breakeven point in order to realize his/her organizations profitability. Furthermore, a breakeven chart can be employed by an entrepreneur to predict the effect of any changes in the sales prices. Ultimately, the chart offers a prediction of the effects of costs as well as efficiency changes in an organizations profitability.
Figure 1: Diagram showing a breakeven chart based on the variables of total revenue, total costs, fixed costs, sales and variable costs.
Accountants Breakeven Chart
This is a line graph that shows an organizations breakeven point, which is a sales level in which a business organization creates exactly zero profits. That is provided the business organization meets the specific amount of fixed costs that it must pay during a specified period in its financial calendar. During the computation of the accounting breakeven point, it is assumed that any change in the business expenses has been matched by an equal change in the organizations revenue incurred. This shows that the difference between the economist and accountants breakeven charts is based on the definition of the breakeven point. For instance, the economist breakeven point characterizes a point where total sales revenue becomes equal to the total costs, but in the accountant breakeven chart, breakeven is when the sales of an organization are exactly zero.
Figure 2: Diagram showing an accountants breakeven chart.
Fixed Costs Analysis
These are costs that remain the same even when the production activity changes CITATION Rob05 \l 1033 (Scarlett, 2005). They are also the costs that do not change despite an increase or decline in the volume of products produced and retailed. There are two primary aspects of fixed costs. These include the cost relevant range and cost period of time.
Cost Relevant Range
These are the specific level costs that are bounded by both a minimum as well as a maximum amount. Additionally, these are costs that lie within a designated boundary within a corporation. Also, in a business setting, an entrepreneur can classify costs that lie in the defined scale of maximum and minimum costs to be within the cost relevant range. Furthermore, to operate at an optimal profitability level, an entrepreneur must make the assumption that all the fixed expenses in the organization lie within the cost relevant range. Additionally, the costs relevant range assumes that at a certain range of cost defined activity, the total fixed costs as well as per unit variable costs are linear, or remain the same. Ultimately, the relevant range can be used to describe a band of volume whereby the total fixed cost remains constant at a particular level.
Cost Period of Time
This is the period within an organization that is characterized by expenses that occur due to the passing of time. Additionally, these are costs that are associated with the passage of time and not with a transaction event. Additionally, period costs cannot be classified as prepaid expenses, fixed assets or inventories. It also characterizes costs such as depreciation, rent, interest, as well as the costs associated with the passage of time and then treated as fixed costs. Moreover, the period costs also entail the selling as well as administrative expenses identified with the financial period in which they were incurred. Additionally, such expenses are charged against the business organizations sales revenue during the same period. Furthermore, such expenses are also characterized as the period expenses. Additionally, the expenses that occur at the cost period of time are not included in an organizations cost of goods sold as well as the income statement.
Breakeven Point and Margin of Safety
The breakeven point is the point in an organizations sales volume in which an entity earns no profit CITATION Mic10 \l 1033 (Cafferky, 2010). It also represents the period at which the total revenue realized by an organization is sufficient to cover all the fixed and variable costs in the organization. Additionally, at the breakeven point, the total amount of profits that is realized by an organization is zero. Furthermore, this point is useful in determining the outstanding capacity after the breakeven point is attained, which is essential in calculating the maximum possible amount of profit that can be realized.
On the other hand, the phrase margin of safety refers to the difference that exists between the intrinsic value of a stock and the market price of the stock (Jain, 2010). During the breakeven analysis, the margin of safety is employed to characterize the volume of output levels, which can be employed before an organization attains its breakeven point. Furthermore, in an organization, the formulation of the margin of safety is important because it informs the entrepreneur on how much reduction in the attained revenue can make the business to breakeven. Additionally, a high level of breakeven reduces the level of risk that organization faces in terms of losses.
Breakeven Point Formula
The breakeven point is attained through the division of the total fixed costs incurred in an organization during production, with the price per unit minus the variable costs associated with producing the product CITATION Ste08 \l 1033 (Nelson, 2008). This formulation is represented by the equation below.
Additionally, in the computation of the breakeven point, the sales price per every unit of the product sold less the variable cost associated with selling every unit of that product is also known as the contribution margin. As such, the breakeven point can also be formulated using the equation below.
Margin of Safety Formula
This is a ratio that evaluates the volume of sales can exceed the break-even point. Additionally, the margin is formulated by subtracting the total amount of the break-even sales from an organizations projected or budgeted sales (Kimmel et al., 2009). Furthermore, the formula portrays the total amount of sales that lie above the business breakeven point. The formula below can be used in the formulation of the margin of safety.
Additionally, the margin of safety can also be formulated by subtracting the breakeven point from the actual sales realized in an organization and then dividing the result by total actual sales amount or the organizations selling price per unit. This formulation can also be shown by the equation below.
In conclusion, the cost-volume-profit (CVP) analysis is undertaken in order to determine how the changes in the entitys costs and volume, affect its operating and net income. The economist breakeven chart is a line graph that is employed to formulate an estimation of the point at which the total sales revenue becomes equal to the total costs. On the other hand, the accountants is a line graph that shows an organizations breakeven point, which is a sales level in which a business organization creates exactly zero profits. Additionally, the cost relevant range defines the specific level costs that are bounded by both a minimum as well as a maximum amount. It is also used to describe a band of volume whereby the total fixed cost remains constant at a particular level. Contrary, the cost period of time refers to the costs that are associated with the passage of time and not with a transaction event. Additionally, the breakeven point is the point at which the total revenue realized by an organization is sufficient to cover all the fixed and variable costs in the organization. On the other hand, the margin of safety refers to the difference that exists between the intrinsic value of a stock and the market price of the stock.
Cafferky, M., 2010. Breakeven Analysis: The Definitive Guide to Cost-Volume-Profit Analysis. New York: Business Expert Press.
Jain, P. C., 2010. Buffett Beyond Value: Why Warren Buffett Looks to Growth and Management When Investing. Illustrated ed. New York: John Wiley & Sons.
Kimmel, P. D., Weygandt, J. J. & Kieso, D. E., 2009. Accounting: Tools for Business Decision Making. Illustrated ed. New York: John Wiley & Sons.
Nelson, S. L., 2008. QuickBooks 2008 All-in-One Desk Reference For Dummies. Illustrated ed. New York: John Wiley & Sons.
Scarlett, R., 2005. Management Accounting-Performance Evaluation. Illustrated ed. New York: Elsevier.
Shim, J. K. & Siegel, J. G., 2009. Modern Cost Management & Analysis. Revised ed. New York: Barron's Educational Series.
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