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Profit Volume Analysis for Managerial Accounting Mcom delhi University

Profit Volume Analysis for Managerial Accounting Mcom delhi University

Profit Volume Analysis for Managerial Accounting Mcom delhi University:- we will provide complete details of Profit Volume Analysis for Managerial Accounting Mcom delhi University in this article.

Profit Volume Analysis for Managerial Accounting Mcom delhi University

Profit Volume Analysis (Explained With Diagram)

A P/V graph is sometimes used in place of or along with a break-even chart. Profits and losses are given on a vertical scale, and units of products, sales revenue or percentage of activity are given on a horizontal line. The horizontal line is drawn on the graph to separate profits from losses.

The profits and losses at various sales levels are plotted and connected by the profit line. The break-even point is measured at the point where the profit line intersects the horizontal line. The PV graph may be preferred to the break-even chart because profit and losses at any point can be read directly from the vertical scale, but the P/V graph does not clearly show how costs vary with activity.

Break-even Chart Showing Cost and Profit Details

Data used earlier to prepare the break-even chart are also used in preparing the P/V graph (see Exhibit. 6.3):

Profit Volume (P/V) Graph

Basic Assumption in CVP Analysis:

CVP analysis is based on several assumptions.

Whether income is computed under the absorption or marginal (variable) costing concept, these assumptions include the following:

1. Selling prices and pricing policy will remain constant at all sales levels; no quantity discounts are assumed to be available. If this is not true, sales revenue cannot be plotted as a straight line.

2. All costs and expenses can be separated into fixed and variable components.

3. The total of the fixed costs is constant at all sales levels; the unit variable costs remain the same and there is a direct relationship between costs and volume. If this is not true, straight lines cannot be drawn.

4. Production and sales quantities are equal.

5. Managerial policies, technological methods, and efficiency of men and machines will not change and cost control will be neither strengthened nor weakened.

6. Volume is assumed to be the only important factor affecting cost behaviour; other influencing factors such as unit prices, sales-mix, labour-strikes, and production methodology are ignored. Any change in cost behaviour will need the break-even point to be modified.

7. In case of multiple products being manufactured by the enterprises, the sales-mix should remain unchanged. That is, the calculation of the break-even point in the case of multiple products predetermines the number of units to be sold in respect of each product. This multiproduct sales-mix should remain unchanged.

Profit Volume Analysis for Managerial Accounting Mcom delhi University

Profit Volume Ratio

Profit volume ratio or P/V Ratio is the ratio of contribution to sales. It tells us what percentage of sales revenue is the contribution, if considered in percentage form. It is useful in estimating the relationship between profit and sales of the firm. A high P/V ratio indicates that a larger portion of sales revenue forms part of the profit for the firm. It is one of the greatest tools available to managers to analyse the relationship between cost volume and profit with regard to the product or  a service. Similarly, a low P/V ratio means a lesser portion of sales revenue becomes firm’s profit or a large portion of sales revenue covers the cost of the firm. One can take it as a large portion of sales is covering variable cost and thus leaving only a small portion to cover fixed cost and leaves a less profit.

P/V Ratio            =      Contribution / Sales

=     Total Sales Revenue – Total Variable Cost /Sales   P/V Ratio can also be computed as:

=      Fixed Cost +Profit/Sales

=    Change in Contribution  / Change in Sales

If due to some reason there is an increase in contribution then there is bound to be an equal amount of increase in profit as fixed cost remains same or constant. Therefore,

P/V Ratio    =     Change in Profit   / Change in Sales

Uses of P/V Ratio

P/V Ratio is of great use to decision makers in a firm. It helps them in following ways:

Estimating Profitability

We are now familiar that P/V Ratio shows ratio of contribution to sales. As it is shown in the percentage terms, we can know if sales are of Rs.100 then the amount of contribution can be easily computed. For example if P/V ratio is 60%, then for a sale of Rs.100 the contribution is Rs.60. Thus, we can say that P/V Ratio helps in determining profitability by selling a product or different products.

Comparison of Profitability

P/V Ratio can be used to compare the profit opportunities from sales of different products, services or by adopting different methods. A manager may be interested in knowing what to do if same product can be made by buying raw material from different sources at different prices and can be sold at different prices. In that case P/V Ratio can be helpful.

Calculation of breakeven point, sales required to earn desired profit, margin of safety

P/V ratio is used for calculating breakeven point, sales required to earn desired profit, margin of safety etc. that will be discussed in the next section.

Value Addition 1: Important Tip
P/V Ratio
It must be noted that P/V Ratio is not taken in isolation by managers in decision making. They are also guided by other tools and techniques also.

Improvement in P/V Ratio

P/V Ratio tells us the percentage of benefit in selling price if only variable cost is taken out but not fixed cost. Therefore, an increase in P/V Ratio without any increase in fixed cost will indicate an increase in total profit of the firm. Thus, we can say that the more the spread between sales and variable cost the better will be the P/V Ratio. And higher the P/V Ratio, better it is for the firm. Thus, manager can improve P/V Ratio:

  1. By increasing the selling price of the product.
  2. By reducing the variable cost of the product.
  3. By making adjustments in the sales mix i.e. increasing the proportion of product having higher P/V ratio and reducing the one with lower P/V Ratio.

Profit Volume Analysis for Managerial Accounting Mcom delhi University

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