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Objectives and assumptions in cost-volume-profit analysis

This is a short article that will walk you through the objectives of CVP analysis and some common assumptions revolving around the process.

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.

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Financial Analysis for Business Performance: Reporting and Stakeholder Management

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