Cost Volume Profit Analysis - Assignment Example

Names: - Saeed Al Romaithi - 212245 - Bader Al Khoory - 212248 - Abdulrahman Al Remeithi - 212224 - Mohammed Al Newais - 212247 - Jarrah Al Dhafairi - 212262 Instructors name: Course: Date: 28/5/16 Cost Volume Profit Analysis 1.1 Introduction Cost volume profit analysis (CVP) is a model that chooses to ignore uncertainty or risk by covering the operating expenses of the business in the initial decision-making process. (Durry, Colin 2008) It constitutes elements such as sales, cost, volume and price; they make it easier to calculate how much sales are needed to achieve the profit required. Assumptions of the model include; fixed cost remain the same, and variable costs change proportionately with volume of sale, variable can be separated into their individual variable and fixed costs, single good or service, sales factor is the only element that affects profit, revenue varies in direct proportionality with volume, no change in stock level and efficiency remains constant. Volume in sales affects the profit which would make higher sale causing higher profits and the lower sales generating lower the revenue and eventual profits. 1.2 Components and Variables 1.2.1 Level of Activity The level of activity is the primary element that occurs in a firm for the sole attainment of profit. An activity that is conducted by a firm includes the number of goods sold and by how much is that good costs. (Garrinson, and Norren, 2005). It also includes the margins this is the cost of producing or buying the good and the selling price of the good. The difference is known as the profit margin, and this is what dictates if the product is viable for sale or not if this difference is high, then the profits are high. 1.2.2 Unit Selling Price Unit selling price is the cost of one item sold when the rate is multiplied by the total amount of units sold it makes up the sales. (Garrinson, and Norren, 2005)This element is essential in calculating the sales, and it is per unit of the total output. Example the total sales of ABC company is 300,000 and the items sold are 50000 the unit selling price would be 6. 1.2.3 Variable Cost Variable cost is expenses that change from time to time, this shift in the CVP model is due to the volume of sales. With an increase in sales, the variable costs increase in such a manner that is proportionate in the same manner. (Durry, Colin 2008)The more the sales, the more the variable costs and vice versa but this is only possible to an absolute limit where sales cannot go any higher. 1.2.4 Fixed Costs A fixed cost is an expense that increases with decrease or increase in sales; this cost is always in the business, and it is paid for regardless if any transaction occurs. (Lucey, Terry 2002) An example is a lease on a building or motor vehicle if the firm should pay the (X) amount of cash each month for three years that cost will reflect monthly on the income statement of the company regardless of the volume of sales. 1.2.5 Sales Mix Sales mix is the percentage of the total number of goods or products that an enterprise sells to consumers. (Lucey, Terry 2002) The amount used when the sales of a firm are calculated, and a mean point of this percentage is achieved. This portion is essential since it gives a rate of efficiency that can be used to calculate for future forecasts of sales or profits that shall be attained. 2. Role of managerial accounting General Managers (GM) and head of departments (HOD) are responsible for decision making in business, one of the questions they have to grapple with when making decisions is the effect of sales volume and product costs to the profits that would be attained. The managers should calculate their sales mix to know what percentage of goods produced are sold; this would enable them to calculate how much volume of sales they will have to attain to reach an individual target of profits. (Garrinson, R. H., and Norren, E. W. 2005). The cost of making or buying the product is also critical because it dictates the growth of profit margin per the number of goods sold. To make an informed decision of what product they are going to sell is also another responsibility endowed to them, a product viability is a key to the success of business. (Durry, Colin 2008) A product should be able to sell and appeal to customers to continue buying more of it time and time again. Appeal in a product should be achieved through value addition, advertising, branding and good quality standards. Managers also have a responsibility of making cost-effective moves; cost reduction is made by reducing the operating expenses. (Lucey, Terry 2002) Cost effectiveness can be achieved by using modernized equipment, following local trends that are cost conscious, reducing the fixed and variable costs. The firm's bottlenecks should be realized, and measures are taken to understand them and to find mitigating factors for all of them. If this is to be done, costs will reduce, and the percentage of profits would also increase. Sales in a firm should be a core activity since a company cannot make profits if there are no sales. (Horngern, Datar, and George, 2006) Emphasis on sales should be key, and motivational factors for increased sales should be put in place to increase the enthusiasm of employees to reach higher targets. The MD's should determine the direct costs of the business and know how much they are also the variable costs this would mean that he has calculated the expenses and knows how much sales should be made to make more profit. 3. Role with managerial accounting (CVP for entrepreneurs) 3.1 Satisfaction of customer profitability Higher customer satisfaction directly influences some sales that will be attained by a firm and despite that it also enhances the ease of calculations due to loyal customers who would have gained. (Horngern, Datar, and George, 2006)The more product or a service satisfies a want, the higher the likelihood of demand for the product to rise. For a service, quality of the service and the treatment that the staff gives to a customer is critical in increasing the revenue and creating a brand that people identify with the company. Managers should work so that they can enhance their awareness on what quality trends would improve their competitive nature and in the end increase the sales of the business; this relationship is the key to the success of a firm. 3.2 Initial Investment Recovery Initial investment recovery is the amount of capital that has been put into a business to run the operations of the enterprise; the sales should be sufficient enough to meet that sum that calculated. (Garrinson, and Norren, 2005). Capital used should be computed in the breakeven amount to know how much sales is required to meet it, breakeven an amount is some sales that should be attained to make sure that the company does not make a loss or profit. It is essential in knowing how much more sales should increase so that a firm can achieve an individual sales target that is attainable. 3.3 Smart Strategy The smart strategy is a plan that is put in place by a company to identify the goals and objectives, to evaluate them, to create programs so that you can achieve the goals and to practice the strategies so that they can come to a realization. (Horngern, Datar, and George, 2006) The purpose of any organization is to make profits; managers should find measures that would enhance their competitiveness to confuse their competitors. This should be done through a proper understanding of the market and customer needs so that they can satisfy them better. Encompassing of modern technology and trends in marketing to increase sales, this would be possible by working with the design team to create desirable products and advertising to create awareness of the product to the customers. 4.0 C.V.P Analysis Example Abu Dhabi National Hotel Company Abu Dhabi National Hotel Company is a hospitality company based in the United Arab Emirates, it came into existence in the late seventies and has been in existence since then. Below is the financial records of the company of the year 2013-2014, which show the company performance and shall be used to illustrate the cost volume profit analysis of the enterprise. An excel sheet has been provided to show this. Revenue: Operating revenue + other incomes+ profit of investment 1,340,166+107,607+94,608= 1,542,381 Expenses: cost of service+ general administrative expenses+ finance costs+ opening expenses 1,143,212+50,601+144,484+3,626=1,341,923 Net profit= revenue – expenses 1,542,381- 1,341,923=200,458 Cost per share= 0.20 Contribution margin: 200,458 4.1.1 What is the break-even point? The break-even point is the point which the revenue and the expenses are equal. A variable (x) will represent the number of units sold. Cost per share multiplied by a variable (x) = expenses 0.20(x) = 1,341,923 (x)=1,341,923/0.20 6,709,615 4.1.2 Target profit in units Let’s assume that Abu Dhabi National Hotel Company has a target profit of 300,000. TF= (Total fixed costs + Target profit)/ (contribution per unit) (1,341,923+300,000)/ (0.20) 8,209,615 5.0 interpretation of outcomes The above information shows that it would be unlikely for the company to reach the target profit due to the increased cost of operation in the hotel sector. The profit margin of three hundred billion AED is a less attainable target nevertheless the breakeven point is attainable this has been illustrated in the excel sheet where the financial records of the following year have been indicated. The company will increase their profit margin slowly, but not rapidly; this is also mentioned in the excel sheet. 6.0 allocation of work done - Saeed Al Romaithi – 212245 did part 1 - Bader Al Khoory – 212248 did part 2 - Abdulrahman Al Remeithi – 212224 did part 3 - Mohammed Al Newais – 212247 did part 4 - Jarrah Al Dhafairi – 212262 did part 5 References 1. Adenji, AAdenji, (2004). An insight into Management Accounting. Value Analysis Consult Bariya, Shomulu, Lagos. 2. Durry, Colin (2008). Management and Cost Accounting. Booking Power Publishers London. 3. Garrinson, R. H., and Norren, E. W. (2005). Management Accounting McGraw – Hid Irwin. 4. Glautier, M. W. E and Underdown B. (2001). Accounting Theory and Practice. Pearson Education Limited. Harlow England. 5. Hilton, R. W (2002). Management Accounting Creating Value in a Dynamic: Business Environment. McGraw Hill Irwin. 6. Horngern, T. C, Datar, S. M and George, F (2006). Cost Accounting: A Managerial Emphasis Pearson Education Incorporation Upper 7. Kalu, J. O, and Mbanasor. J. A. (2004). Fundamentals of Business Management. Toni Publishers Aba. 8. Kaplan, R. S and Atkinson, A. A. (1998). Advanced Management Accounting. Prentice Had Upper Saddle River, New Jersey. 9. Lucey, Terry (2002). Costing. TJ international Padstow Cornwacl. Read More