📊 Cost Volume Profit (CVP) Analysis

A strategic financial tool to understand the effect of costs and volume on profits.

📌 What is CVP Analysis?

Cost Volume Profit (CVP) Analysis is a method used to examine how changes in:

• 🔁 Sales Volume

• 💸 Costs (Fixed + Variable)

• 💰 Profits

…impact a business’s financial performance.

It helps managers to:

• Plan future profits 🧠

• Decide pricing strategies 💵

• Control costs 📉

• Forecast break-even points 🎯

➗ CVP Analysis Formula

📌 Profit = (Sales Price × Quantity Sold) – (Fixed Costs + Variable Costs × Quantity Sold)

🔍 Let’s break it down:

• Sales Price (P) ➝ Price per product sold

• Quantity (Q) ➝ Number of units sold

• Fixed Costs (FC) ➝ Constant costs (e.g., rent, salaries)

• Variable Costs (VC) ➝ Costs per unit (e.g., materials, packaging)

🔄 As sales ↑ or ↓ → impact on profit is calculated using this formula

🧱 Assumptions of CVP Analysis

CVP simplifies reality with these assumptions:

➡️ Linear Costs & Revenues:

Price and variable cost per unit remain constant

➡️ Constant Sales Mix:

Product mix in total sales stays the same

➡️ Fixed Costs Stay Fixed:

No change in FC despite sales or production change

➡️ Sales = Production:

No unsold inventory; all produced items are sold

➡️ Efficient Operations:

No wastage or delays in operations

🎯 Objectives of CVP Analysis

✔ Determine sales needed to cover costs

✔ Identify the profit-making point

✔ Support price setting & cost control

✔ Assist in budgeting and financial planning

🌟 Importance of CVP Analysis

CVP helps in:

• Setting right prices 📈

• Planning production volume 🏭

• Making financial forecasts 📅

• Identifying risk zones before losses occur ⚠

• Supporting strategic business moves 💼

✅ Advantages of CVP Analysis

✔ Simple to apply and understand

✔ Shows how cost changes affect profits

✔ Useful for decision-making

✔ Effective for short-term planning

❌ Limitations of CVP Analysis

⚠ Unrealistic assumptions (like linearity and constant FC)

⚠ Ignores market conditions & external risks

⚠ Assumes sales = production (no inventory)

⚠ Difficult for companies with multiple product lines

🆚 CVP Analysis vs. Break-Even Analysis

     Cost & Sales Volume ➡️ CVP Formula ➡️ Break-Even Point 🎯
             ⬇️
        Financial Decisions ➡️ Pricing | Production | Cost Control
             ⬇️
          Strategic Planning 💼

✨ Conclusion

Cost Volume Profit (CVP) Analysis is more than just a formula — it’s a financial guide for making smart business decisions. Whether you’re pricing products or planning growth, CVP shows you the road to profitability.

📘 Budgets and Budgetary Control

“A budget is a plan quantified in monetary terms for a specific future period.” – CIMA UK

🧾 Meaning of Budget

🔹 Derived from French word ‘baguette’ → little bag or document container

🔹 A formal action plan in money terms

🔹 Shows expected income & expenses under assumed conditions

🔹 A blueprint for future activities

➡ In Simple Words: A budget is a future financial plan used for decision-making and control.

🧠 Definitions

📌 CIMA: Plan in monetary terms, showing income, expenditure, and capital use.

📌 Keller & Ferrara: Action plan based on assumptions to meet goals.

📌 G.A. Welsh: Written plan for future activities over a defined time.

🧮 What is Budgetary Control?

🔹 A method of managing costs by comparing budgeted vs actual results.

🔹 Helps take corrective action or revise plans.

📌 CIMA: “Establishment of budgets with continuous comparison and revision.”

🎯 Objectives of Budgeting

1. Planning
   
   ➤ Think ahead → Predict problems → Plan solutions

2. Coordination
   
   ➤ Align different departments → Avoid conflict

3. Measurement of Success
   
   ➤ Compare performance vs targets

4. Motivation
   
   ➤ Employees feel responsible if involved in budget creation

5. Communication
   
   ➤ Share goals, restrictions, and expectations

6. Control
   
   ➤ Monitor if things are going as planned

✅ Advantages of Budgetary Control

✔ Sets clear policies & direction

✔ Encourages teamwork

✔ Ensures efficient use of resources

✔ Reduces waste & controls costs

✔ Helps in performance tracking

✔ Useful for getting bank credit

✔ Supports planning & coordination

✔ Seen as a sign of good management

⚠️ Limitations of Budgeting

❌ Can cause rigidity in operations

❌ Expensive & complex for small businesses

❌ Not a substitute for good management

❌ Can cause managerial conflicts

❌ If poorly implemented → morale drops

❌ Requires skilled staff & setup → high cost

🧩 Types of Budgets (Functional Classification)

🛠️ Flexible Budget

🔄 A budget designed to change with different levels of activity

🔹 Used when output levels are uncertain

🔹 Adjusts for actual activity level → more accurate control

🔁 Summary Flow → Easy Revision

Budget (💰)
    ↓
Planned Income + Expenditure = Goal Achievement 📈
    ↓
Budgetary Control 🔍
    ↓
Compare Actual vs Budgeted → Take Corrective Actions ✅

📚 Quick Recap

 What is Responsibility Accounting?

➡ Definition: A system of management control where responsibility is assigned to individuals for controlling costs and performance within their department or division.

➡ It focuses on:

• People (managers), not just systems.

• Comparing planned vs actual costs & revenues.

• Evaluating performance of divisions (responsibility centres), not the organisation as a whole.

📌 Horngreen’s Definition:

“Responsibility accounting recognises responsibility centres and assigns costs/revenues to those responsible. Also called profitability or activity accounting.”

📌 ICWAI Definition:

A system where accountability is established according to delegated responsibility at each management level, using reports for feedback.

🔹 Key Features of Responsibility Accounting

1️⃣ Inputs & Outputs → Costs & Revenues

✔ Inputs = Raw material, labour hours → Costs (monetary)

✔ Outputs = Goods/services → Revenues (monetary)

2️⃣ Planned vs Actual Info (Budgeting)

✔ Requires budgeted and actual data

✔ Uses tools like:
→ Fixed budgets

→ Flexible budgets

→ Profit planning

3️⃣ Identification of Responsibility Centres

✔ A segment or division under a manager

✔ Big firms divide into manageable units

✔ Each unit = evaluated independently

📌 E.g., A manager responsible for just one machine or an entire production division

4️⃣ Organisation Structure Alignment

✔ Authority ↔ Responsibility should be clearly defined

✔ System must mirror organisational hierarchy

✔ Reports must help in performance evaluation

5️⃣ Assigning Controllable Costs

✔ Assign only controllable costs/revenues to managers

✔ Guidelines:
→ Has authority over cost? ✅ Assign it

→ Can influence cost? ✅ Assign it

→ Cannot directly control but relevant? ✅ Assign for awareness

6️⃣ Performance Reporting

✔ Performance Reports = Responsibility Reports

✔ Flow = Bottom to Top

✔ Should include:
→ Budget vs Actual

→ Variances (controllable & non-controllable)

✔ Use charts, tables, graphs for clarity

🔹 Pre-requisites of Responsibility Accounting

✅ Divisional structure

✅ Clearly defined goals & targets

✅ Managerial participation in budgeting

✅ Managers accountable for controllable activities

✅ Timely performance reporting

🔹 Types of Responsibility Centres

1. 🧾 Cost Centre

✔ Manager controls costs only

✔ No control over revenue

✔ Examples:

→ Production dept

→ Maintenance dept

→ Accounting dept

2. 💰 Revenue Centre

✔ Manager controls sales/revenue generation

✔ No control over costs/investments

✔ Example: Sales department

3. 📊 Profit Centre

✔ Manager controls costs & revenues → hence profit

✔ Encouraged to act like a business owner

✔ Responsible for:
→ Product mix

→ Selling price

→ Marketing strategy

4. 🏢 Investment Centre

✔ Manager controls costs, revenues & asset investments

✔ Highest level of responsibility

✔ Examples:
→ New business unit

→ Hotel division with full autonomy

🔹 Steps in Responsibility Accounting

1️⃣ Divide organisation → responsibility centres

2️⃣ Set goals/targets with centre managers

3️⃣ Compare actual performance with targets

4️⃣ Report variances & assign responsibility

5️⃣ Take corrective actions timely

📌 Goal: Improve performance & fix responsibility

✅ Advantages

✔ Fixes individual accountability

✔ Improves cost control & planning

✔ Boosts motivation & initiative

✔ Helps in performance appraisal

✔ Provides relevant, real-time data

⚠️ Problems / Limitations

✘ Difficult to classify controllable vs non-controllable costs

✘ May lead to inter-departmental rivalry

✘ Only a directional tool, not a full control system

✘ Preparing responsibility charts is complex

✘ Risk of information overload in reports

🔹 Divisional Performance: Concept

✔ Organisation is divided into divisions with independence

✔ Each division = responsibility centre

✔ Manager accountable for:
→ Operations

→ Profitability

→ Investments

✔ Encourages decentralisation & self-driven units

📝 Summary Chart: Types of Responsibility Centres

1. What Are Make or Buy Decisions?

➡️ These are decisions where a company decides whether to manufacture a product internally or buy it from an external supplier.

🔁 Why Is It Important?

• Helps in cost-saving

• Impacts employee retention

• Affects factory efficiency

• Useful during expansion or cost-cutting

🎯 2. Situations That Call for Make or Buy Decisions

✅ When the company is already making a product

✅ But the same product is available in the market at a cheaper price

✅ Need to evaluate:

• Is buying cheaper in the long run?

• Can we maintain quality & supply?

• Are there hidden costs in outsourcing?

📌 3. Key Factors to Consider Beyond Cost

🧠 4. Numerical Illustration

A company is considering whether to buy an item or continue making it internally.

📊 Given Data:

📑 5. Statement of Cost & Profitability

✅ 6. Decision & Analysis

🟩 Making the item in-house is better, because:

➡️ Profit increases by ₹56,000

➡️ P/V Ratio improves by 6%

➡️ Profit Margin on sales increases by 3.5%

➡️ Return on Capital Employed increases by 4.6%

💡 Conclusion: Despite a slight increase in fixed costs, making the product internally results in better financial performance.

🧷 7. Summary Table

🧾 8. Final Thought

📌 Make or Buy is not just a cost comparison — it’s a strategic decision that considers quality, secrecy, reliability, and long-term value.