Objectives and assumptions in cost-volume-profit analysis

Let’s try to understand the core objectives of cost-volume-profit (CVP) or break-even (BE) analysis followed by some assumptions underlying these objectives.

Cost-volume-profit or break-even analysis objectives

• To forecast profits: helps to identify profit relationships, costs and volumes for determining relative profitability and to compare inter-company profitability
• To set budgets: is useful in setting up flexible budgets that indicate costs at different activity levels
• To evaluate performance: helps performance evaluation by focusing on profits achieved and costs incurred
• To set pricing: plays an important part in stabilising volume. BE analysis helps organisations to formulate pricing policies
• To determine overheads: helps to determine the number of overheads that should be allocated to product costs at different levels of operation
• To achieve capacity: focuses on the importance of achieving capacity to achieve economy.

Assumptions

Here are some assumptions about the use of CVP analysis in business.

• CVP analysis costs can be segregated into fixed and variable portions and total fixed costs remain constant at all output levels.
• In CVP, cost linearity is preserved over the relevant range, and revenues are constant per unit.
• A business has a constant product mix and produces only one kind of product.

An efficient manager or business owner tries to bring out the best results from cost-volume-profit analysis, while steering clear of assumptions.