Cost Volume Profit Analysis Essay
Introduction
Cost volume profit analysis examines the interaction of a company’s sales volume, selling price, cost structure, and profitability.
CVP analysis is a useful tool in making management decisions such as production, investment, and financing decisions. Wonder Company simulation has to establish various factors that influence its product sales and customer demand. The success of a company is based on how many people are willing to purchase their products at existing prices. Competition is inevitable in case a company does not have monopoly powers. Brand management seeks to promote the presence of a company in the market. Many companies are investing heavily in brand management to improve sales by attracting more customers and retaining existing ones. Company products follow an inevitable life cycle. A life cycle of a product begins with the conception of an idea on what to produce, how to create, and who will constitute a market for the product. The product is then moved to the product development stage, where it is delivered and finally availed to the market for consumers to purchase and use it. After several years in the market, a company might fail to upgrade its product based on existing market requirements leading to consumers opting to use alternative products. Lack of market may result in a company failing to meet its objectives and eventually wound up. In such cases, the company withdraws its products in the market. Brand management takes place in various forms. It begins with the assessment of how customers are relating to a product in the market and proceeding to evaluate how their perception of the product changes with time. Consumer perception of a product significantly determines company success.
Brand management goes further to evaluate customer awareness of company products. Some consumers always wish to try new products with the hope of getting a better experience. Companies have to ensure at all times; customers prefer their products over other company products. Company administrators require knowledge of consumer evolution and preference for product tastes. Companies should be able to develop strategies that ensure even with customer changing tastes; they can offer products that meet consumer needs (Kipesha). The attractiveness of a brand is fundamental in designing a product or branding a company. Famous brands have an advantage over companies that have not developed their brands better. With the growth in technology, many companies can simulate their products and processes and determine if there is a need for improvement and how the improvements can be made. Cost of carrying out a simulation or research to assess the effectiveness of a brand to meet consumer needs (Bergo, Lucas and Sobreiro). Customers’ preferences and challenges while using a product vary significantly from one customer to another. Even when customers share the same product, each will have a unique experience with the product that will affect how they wish to interact with the product in the future. Competition has also affected customer satisfaction. Some customers claim that variation in tastes or preferences affects how they react to a product. Cost volume profit analysis takes into account variation costs and volume about company performance. Customer preferences always affect the quantity of a product a company will make a sell. Managers should review how consumers perceive their products to make effective changes that will ensure more sales are made within a given period.
Cost volume profit analysis evaluates how many units of a product a company has to sell to make profits. Based on the cost volume profit analysis, benefits to be achieved is based on the price of the goods minus the cost of production (Said). Variable costs are also considered in profit determination. Before making profits, a company should break even. Before breaking even a company has to use its resources in production. Careful planning is required to ensure that a company does not exhaust its remedies before it breaks even. With advancements in technology, companies are investing a lot in research and development to ensure they have information and develop capacity on what is required to break even and make profits from the production and sale of a new product. There exist two approaches to breaking even. The first approach relates to breaking even based on the volume of goods produced.
In such a scenario, a company should produce a given volume of goods and sell them to make profits. Failure to sale the specific volume of goods will result in loses for the company. Many companies are striving to sale more quantities of products to break even. In the case of breakeven price, a company evaluates its performance based on price (Kipesha). Various factors guide price determination. Managers always strive to operate within the costs to make their products affordable to many customers. Products should not be too expensive as that may result in too many customers opting for alternative goods. In many instances, customers are always sensitive to the prices of goods and services. Consumers’ reactions to price variation might affect the demand for a product.
The cost volume profit model considers various issues in determining profits for a company. The first assumption the model makes relates to the selling price of a company`s products. The model assumes a company has a fixed selling price for its goods irrespective of prevailing demand and supply forces (Etges, Calegari and Rhoden ). It might not be practical to maintain constant prices all the time. On many occasions, companies vary the prices of their goods and services to meet variable and fixed costs related to producing the products. Issues such as an increase in cost of power or workers’ compensation may necessitate the increase in prices of a commodity. It has also been established that variation in prices can be cost by inflation in case of importation of raw materials used in production. Cost volume profit analysis assumes the prices of a product remained constant over a given period. Assumptions to retain prices regular is based on the need to have stable figures that make the computation easier. Though not practical in actual operation, prices can remain constant in some instances. Slight variation in prices is ignored while using the cost volume profit analysis.
The second assumption made relates to the movement of prices. Cost volume profit analysis assumes that the cost associated with a product remains linear and can be divided into variable and fixed costs (Bergo, Lucas and Sobreiro). Variable cost and fixed costs can keep on constant or vary based on prevailing market conditions. The cost must be linear to indicate an increase or decrease in the prices of the goods. A linear increase or decrease suggests a relationship between the previous and current estimates of the product.
The third assumptions relate to the number of products the company deals with. Cost volume profit analysis assumes that a company deals in several products, and the industry has several other companies producing similar or related products. Companies engage in product sales mix to influence potential consumers to buy the profits (Kipesha). The sales mix is based on numerical statistics. The sales mix establishes the proportion of each product a company sells in relationship to the total sales a company makes over a given period. It is essential to examine a company’s sales mix because some products always provide higher returns than others. It has become common for companies to engage in the production of certain goods and services with the aim of not making profits but using the products to entice consumers to use other products and services the company produces. The sales mix determines the percentage of each product about total sales (Said). Based on the cost volume profit analysis presented, it is seen that the company manages to a specific volume of goods, which varies across the company products list. While some goods are popular hence attracting more consumers, some assets are not very popular. Therefore they do not attract many consumers. However, each product contributes differently to the total profits realized by the company. Some products, even if they sell in high volume, results in very little profits for the company whereas some products also, if sold in low quantities, generate a lot of profit for the company. Variation in production is, however, considered as it influences the number of benefits realized (Bergo, Lucas and Sobreiro). Assuming a constant sales mix serves to ensure products with a low-profit margin are not ignored in the determination of the number of gains realized. A continuous sales mix ensures all products are given equal consideration.
Inventory management is essential in profit determination. Companies that produce a lot of goods and store them for some time have to keep a record of all rights provided. Inventories capture product information such as when the product was created, its physical features, and associated prices. Stocks are common in manufacturing companies. Cost volume profits models assume that a company’s stock remains constant.
Prices of goods and services have to be forecasted when using a cost volume profit analysis. Approximating future rates of a product can be difficult, especially when there are uncertainties on the demand and supply of a product. The price of a product must be known when forecasting how much profit can be realized from the sale of the product. Price forecasting is guided factors such as price policies based on the demand curve and other factors such as a growing or shrinking business space. Companies have to consider existing systems regarding the prices of goods and services when affixing prices for their products. Price determination follows a meticulous process that also takes into account what other industry players are charging and the quality of products.
In price forecasting, it is also essential to carry out extensive studies to establish how a change in price will affect demand and supply for the product (Etges, Calegari and Rhoden ). Market research should be an ongoing activity. Issues that will influence customers to either buy or not buy a product today might change over time hence the need to carry out extensive market research whenever using a cost volume profit analysis model.
While conducting market research, it is advisable to consider past sales volumes and issues that might have contributed to increased or decreased sales volume in the past. Sales records are needed in evaluating previous sales records. Apart from sales volumes, general economic and industry conditions are also examined (Bergo, Lucas and Sobreiro). Demand for a product is influenced by various factors, some of which a company has no control over. In the case of a struggling economy, it might be difficult for companies to sell high volumes. Industry conditions also relate to issues such as competition in the market. High competition in the market favors established companies that can produce high amounts at low prices. Other prevailing conditions such seasons also affect market demand. Some factors of production are seasonal, for example, in the case of agricultural goods. Demand and supply might vary based on environmental conditions that influence demand and supply of products.
Cost volume profit analysis also examines relations of sales to economic indicators such as gross national product and personal income. Other issues that affect the supply of a product hence the cost and volume that will ensure maximum profits include advertisement. Advertisement always seeks to remind consumers of the existence of a product in the market. With constant ads, consumers will be informed of changes in a product hence influencing them to buy the product. Cost volume profit sales analysis does not consider the quality of the sales team, which plays a crucial role in advertising and meeting prospecting clients. The model also fails to evaluate how competing might be limiting a company’s ability to make profits from the sales of its products.
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References
Bergo, G. S. Z., Lucas, B. H., Sobreiro, V. A., & Nagano, M. S. (2016). Multiproduct Cost-Volume-Profit Model: A Resource Reallocation Approach for Decision Making. Journal of Cost Analysis and Parametrics, 9(3), 164-180.
Etges, A. P. B. D. S., Calegari, R., Rhoden, M. I. D. S., & Cortimiglia, M. N. (2016). Using cost-volume-profit to analyze the viability of implementing a new distribution center. Brazilian Journal of Operations & Production Management [recurso eletrônico]. Rio de Janeiro, RJ. Vol. 13, n. 1 (Mar. 2016), p. 44-50.
Kipesha, E. F. (2016). FINCARE LTD: Cost, Volume, and Profit Analysis. Case Studies Journal ISSN (2305-509X)–Volume, 5.
Said, H. A. (2016). Using Different Probability Distributions for Managerial Accounting Technique: The Cost-Volume-Profit Analysis. Journal of Business and Accounting, 9(1), 3.