📊 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.

🔹 What is Relevant Costing?

➤ Relevant Costs = Costs that change with decision alternatives.

➤ These are future-focused, not based on past data.

➤ Also called Decision Costs or Differential Costs.

🧠 Key Idea:

Only those costs are relevant that change due to the choice of one alternative over another.

📌 Example:

An engineering graduate can either:

1️⃣ Start a workshop

2️⃣ Continue studies

• 📚 Relevant costs for studying: Fees, books

• 🏠 Irrelevant costs: Clothes, housing (remain same in both cases)

🔹 Characteristics of Relevant Costs

✔ Only future costs

✔ Must differ between alternatives

✔ Can include variable or fixed costs if they change with decision

✔ Do not include sunk or past costs

🔹 Differential Costs (Net Relevant Cost)

➤ The difference in total cost between two decision alternatives.

➤ Can be fixed or variable, if they change due to the decision.

📌 Example:

• Option A Cost = ₹10,000

• Option B Cost = ₹12,000
  
  🧮 Differential Cost = ₹2,000

🧠 Important Notes:

• Not calculated per unit, but as total cost difference

• Only relevant to the current decision

• Influenced by non-cost factors too (e.g. govt. policies, employee behavior, social impact)

🔹 Steps in Decision Making

1️⃣ Identify the Problem

2️⃣ List Available Alternatives

3️⃣ Evaluate Alternatives (Use cost-benefit & differential cost analysis)

4️⃣ Choose the Most Profitable Option

🔹 Important Business Decisions Based on Relevant Costs

🔻 Irrelevant Costs (Opposite of Relevant Costs)

➤ Costs that do not change with decisions

➤ Usually include fixed costs that remain constant in short term

➤ Example: Rent, salaries (in most cases)

🔶 What is Management Accounting?

Management Accounting is the process of preparing management reports and accounts that provide accurate and timely financial and statistical information to managers for decision-making.

🔶 Features of Management Accounting

• Future-oriented

• Uses both financial and cost data

• Helps in planning and decision making

• Focuses on internal users

• Flexible and analytical

🔶 Scope of Management Accounting

• Financial Accounting

• Cost Accounting

• Budgeting

• Forecasting

• Tax Planning

• Reporting

• Internal Controls

🔶 Objectives of Management Accounting

• Assist in decision making

• Increase efficiency

• Plan and control operations

• Provide relevant information

• Maximize profits

✅ Techniques of Management Accounting

Management Accounting uses various tools to help in decision making. These techniques are:

1. Financial Planning
   
   Planning future financial actions including estimating capital, sources of funds, and returns.

2. Financial Statement Analysis
   
   Analyzing income statements, balance sheets using:

   • Comparative Statements

   • Common-size Statements

   • Ratio Analysis

3. Fund Flow Analysis
   
   Evaluates changes in financial position and working capital between two time periods.

4. Cash Flow Statement
   
   Tracks cash inflows and outflows. Helps in short-term financial planning.

5. Standard Costing
   
   Sets cost standards, compares with actual, finds variances, and controls costs.

6. Budgetary Control
   
   Sets budgets for different units and compares actual results with budgets to control performance.

7. Marginal Costing
   
   Helps in cost control and decision-making (e.g., make or buy). Divides cost into fixed and variable.

8. Ratio Analysis
   
   Analyzes liquidity, solvency, and profitability ratios for internal decision making.

9. Cost-Benefit Analysis
   
   Compares costs with expected benefits using tools like differential costing, ABC costing.

10. Statistical Analysis
    
    Uses data sampling and statistical tools to analyze business information for better decisions.

🔶 Role of Management Accounting in an Organization

• Resource Allocation – Helps in best use of limited resources.

• Performance Measurement – Finds responsibility centers and measures efficiency.

• Risk Assessment – Evaluates and minimizes risk in decisions.

• Coordination – Aligns organizational activities via planning and forecasting.

• Performance Comparison – Identifies deviations from expected performance.

• External Compliance – Helps in preparing reports for government agencies.

• Environmental Scanning – Identifies external social, economic, and legal forces affecting the organization.

✅ Match the Following (Check Your Progress)

🔶 Advantages of Management Accounting

• 📌 Effective Decision Making

• 🔮 Future Planning

• 📈 Improves Efficiency

• 🧭 Planning & Forecasting

• 🔐 Control Over Operations

• 🔋 Employee Motivation

• 🔄 Optimal Resource Use

• 🗞 Keeps Management Informed

🔶 Functions of Management Accounting

• Planning and Forecasting – Budgeting, standard costing

• Analysis and Interpretation – Evaluating financial and cost data

• Coordinating – Aligning departmental activities

• Communicating – Sharing budgets and reports

• Tax Administration – Handling taxation-related tasks

• Decision Making – Providing relevant analytical inputs

📌 Remember:

Management Accounting is not only about recording numbers; it’s about interpreting those numbers to take action.

Methods of Costing

Costing refers to the technique used to determine the cost of products or services. The method used depends on:
→ Nature of the product

→ Scale of production

→ Type of industry

✨ Classification of Costing Methods

Costing methods are broadly divided into:

1. Specific Order Costing
   ↳ Job Costing
   ↳ Contract Costing
   ↳ Batch Costing

2. Continuous Operation Costing
   ↳ Process Costing
   ↳ Unit/Single Costing
   ↳ Operating Costing
   ↳ Multiple/Composite Costing
   ↳ Operation Costing
   ↳ Activity-Based Costing (ABC)

🔹 1. Job Costing 🌟(Expanded)

Used when work is done as per specific customer order and every job is unique.

✅ Industries: Road construction, automobile repair, custom furniture

🔑 Key Features:
→ Each job is treated as a separate cost unit

→ Costs are collected individually for every job

→ Labour, material & overhead tracked per job

→ Helps in finding the profit/loss for each job

🛠️ Example:

A customer orders a custom wardrobe. The cost of wood, labour, polish, and design are tracked only for that order.

📊 Advantages:
→ Accurate costing per client

→ Useful in pricing and profit analysis

→ Avoids over/under costing

🔹 2. Process Costing 🌟(Expanded)

Used in industries with continuous production of homogeneous products.

✅ Industries: Cement, textiles, sugar, paper

🔑 Key Features:
→ Production passes through multiple processes/stages

→ Costs are assigned to each process

→ Final cost = Sum of costs from all processes

→ Unit cost is found by dividing total process cost by output quantity

🔄 Example:

In sugar manufacturing:

• Process 1: Crushing sugarcane

• Process 2: Filtering juice

• Process 3: Crystallisation
  
  → Costs calculated at every stage.

📊 Advantages:
→ Helps track cost at each level

→ Suitable for mass production

→ Easy to compute per-unit cost

🔹 3. Activity-Based Costing (ABC) 🌟(Expanded)

A modern method that assigns overheads based on actual activities performed.

✅ Industries: IT firms, telecom, product design, complex manufacturing

🔑 Key Features:
→ Identifies activities (e.g., designing, testing, packing)

→ Costs are assigned to products based on activity usage

→ More accurate than traditional costing

⚙️ Example:

Product A requires:

• 3 hours of testing

• 1 hour of packing
  
  → Testing is more costly than packing. ABC assigns more cost to testing.

📊 Advantages:
→ Accurate cost of complex products

→ Helps eliminate non-value activities

→ Improves pricing and budgeting decisions

🔸 Other Costing Methods (Summarised)

🔹 Contract Costing

→ Large-scale version of job costing

→ Long-term, site-based jobs like buildings, bridges

→ Cost centre = Each contract

🔹 Batch Costing

→ Costing is done per batch of identical items

→ Common in pharma, garments

→ Unit cost = Total cost ÷ number of items in batch

🔹 Unit/Single Costing

→ Suitable for uniform, mass production (e.g., bricks, oil)

→ Cost is calculated per unit

🔹 Operating Costing

→ For services like transport, hotels, cinemas

→ Cost unit = Passenger km, room night, etc.

🔹 Multiple/Composite Costing

→ Used when a product involves multiple components/processes

→ Example: Cars, electronics, watches

🔹 Operation Costing

→ Combination of job & process costing

→ Cost is calculated per operation, not per process

→ Common in assembly line products

Difference Between Marginal and Absorption Costing

📚 Introduction to Costing Methods

👉 Costing is the method of calculating the total cost of producing goods or services.

There are two key approaches:

🔹 Marginal Costing = Variable Costing

✔ Only variable costs are included in product cost.

✔ Fixed costs are treated as period costs → charged directly to P&L.

🔹 Absorption Costing = Full Costing

✔ Both variable + fixed costs are included in product cost.

✔ Fixed costs are absorbed into units → cost per unit increases.

🆚 Marginal vs Absorption Costing – 10 Key Differences

✏ Example: Furniture Company

📌 Marginal Costing

➤ Only counts:

→ Direct materials (wood)

→ Direct labor (carpenter wages)

→ Variable overheads (electricity)

📌 Absorption Costing

➤ Counts all above +

→ Factory rent

→ Admin staff salaries

→ Fixed overheads like insurance

💡 Which One to Choose?

🧠 Business Strategy Impact

🔹 Marginal Costing:

➡ Helps with:

• Short-term decisions

• Launch pricing

• Discount offers

• Survival in competitive markets

🔹 Absorption Costing:

➡ Helps with:

• Expansion plans

• Long-term pricing

• Investor trust (compliance)

• Transparent reporting

👨‍💼 Managerial Implications

🔹 Marginal Costing:

→ Focus = Contribution Margin = Sales – Variable Costs

→ Helps in profit-maximizing decisions.

🔹 Absorption Costing:

→ Focus = Total Cost Picture

→ Helps in finding optimal production levels for maximum profit.

🛠️ Other Costing Methods at a Glance