Cost-Volume-Profit Analysis Essay

695 Words May 4th, 2014 3 Pages
Cost-Volume Profit Analysis

Cost-Volume-Profit (“CVP”) analysis is essential for any company to be able to determine break-even points, and determining short term decisions. Arguably, for small businesses, nothing could be more important, as CVP provides the minimum volume of a product needed to sell in order to experience neither a gain nor loss. For entrepreneurs it is important to be effective and efficient when utilizing CVP accounting processes. This provides the framework for analyzing CVP’s importance to entrepreneurs.
Defined, cost-volume-profit analysis is “the study of the effects of changes in cost and volume on profits” (Kimmel, 2011). CVP is critical in profit planning, determining selling prices, and
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Doing so will help minimize the risk of failure and profit loss. Having adequate data to properly reflect fixed and variable costs allows entrepreneurs to determine whether a product will help maximize profit. Although elementary in terms of its mechanics, CVP is an important tool that many entrepreneurs utilize to make sound business decisions is break-even analysis. Break-even analysis enables an entrepreneur to determine with great accuracy whether or not his/her idea is profitable.
Although break-even and contribution margin are effective in evaluating sales targets, they should not be used on a stand-alone basis. It is important to consider elasticity of demand to determine the price of a good or service and the resulting increase or decrease in sells. In conjunction with CVP, it provides a powerful tool to help entrepreneurs estimate the margin of safety associated with the pricing of a product. Entrepreneurs should also consider whether or not their product has a competitive advantage and can command a higher price or if customers will object to a price hike by switching to a substitute good.
From a theoretical standpoint cost-volume-profit is helpful to entrepreneurs’ in evaluating the company’s profits. However, in real world applications, sales and expenses do not always follow a linear trajectory. Nor are costs always clearly defined as fixed or variable. For instance, rent on a warehouse