Cost Volume Profit Analysis: Establishing a Decision Model

2349 WordsOct 26, 201110 Pages
Ryan Lagano Professor Van Leer Accounting 200-010 Honors Paper Cost Volume Profit Analysis: Establishing a Decision Model In today’s modern world of businesses and corporations, there is a common goal shared throughout every industry: increase profits. With increases in technology and developing methods, businesses have come far lengths in increasing their profits, or operating income. Controlling costs is the key to a successful operation. Executives and managerial departments are using what they know about costs to create business strategies. By gathering information on market demand and combining it with a marketing strategy that focuses on higher margin products, companies are able to continue and increase profits and survive.…show more content…
The contribution margin ratio is the exact percentage of each sales dollar’s percentage towards revenue. So, prior to break even this percentage of each dollar goes towards covering fixed costs. This is a key relationship as seen late for smaller businesses. Beyond this contribution margin, management may also ask, what does sales need to be? This can be covered in units or sales dollars. Either way the basic equation is fixed costs plus desired operating income all divided by the contribution margin (units – CM/unit, sales dollars – CM Ratio). Break-even can be calculated using this formula by simply assuming desired operating income is zero. Another elementary relationship given by CVP is the margin of safety. The actual sales for a given time period minus the break even in sales dollars gives the margin of safety. It is a representation of the dollar amount by which sales can decline before operating losses are incurred. This is crucial for a company to understand what they can endure as far as a downturn in sales. Obviously CVP can answer many various questions management has to ask, but one of the most commonly asked and considered questions is what a company can anticipate as far as a change in operating income. Using the contribution margin ratio, this anticipated change in income can be found by simply multiplying the ratio by the change in sales units. With a common understanding of all of
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