Q: Briefly describe the cost-volume-profit analysis model and discuss how it can be used.

Ans:
A cost volume profit analysis is generally prepared from annual budget figure, but figures

from monthly statements can also be used. Furthermore the analysis can be applied to a specific

product class to distribution outlets, to methods of sale and for profit determination. In an

analysis of the effect of a price decrease on volume, it is often argued that the price decrease will

in most instance be offset by an increase in volume, and therefore, profit will not be reduced and

might even be increased. Such an argument seems quite plausible at first. Cost volume profit in

managerial economics is a form of cost accounting. According to the Caldwell, Charles W., and

Judith K. Welch. "Applications of Cost-Profit-Volume Analysis in the Governmental

Environment." Government Accountants Journal. The CVP analysis looks at the relationship

between selling price, sales volumes, costs and profits. It is a simplified model, useful for

elementary introduction and for short term decisions. CVP analysis expands the use of

information provided by breakeven analysis. A critical part of CVP analysis is the point where

total revenues equal total costs. At this breakeven point can be an initial examination that

precedes more detailed Cost volume profit analysis .Many business people however, have found

that priced reduction does not necessarily lead to the desired increase in volume. If the increase

in volume does occur, it is often not large enough to overcome the effect of the price reduction

on total profit. CVP analysis helps analyze the sensitivity of profits to changes in selling prices,

costs, unit produced and sales mix. It also enables the prediction of costs and profits for different

volumes of activity. It is useful in setting up flexible budgets. It helps in performance evaluation

for the purpose of control. It also helps in formulating price policies to know the amount of

overhead costs, which could be charged to products costs at various levels of operation. It is use

to set the product price.

Reference:

Caldwell, Charles W., and Judith K. Welch. "Applications of Cost-Profit-

Volume Analysis in the Governmental Environment." Government Accountants Journal,

summer 1989, 38.

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