Explain how a CVP analysis can assist management with short-term economic planni
ID: 2599791 • Letter: E
Question
Explain how a CVP analysis can assist management with short-term economic planning. Support your response with examples from your CVP analysis.
Statement showing computations
Particulars
Amount
Revenue from Sale of umbrellas = 5,000*11
55,000.00
Costs:
Direct Materials = 5,000*3
15,000.00
Direct Labour = 5,000*1.50
7,500.00
Variable Manufacturing Overhead = 5,000*.40
2,000.00
Variable Selling expenses = 5,000*1.30
6,500.00
Fixed Administrative Costs
15,000.00
Total Costs
46,000.00
Net Income from special Order = 55,000 - 46,000
9,000.00
Statement showing computations
Particulars
Amount
Revenue from Sale of umbrellas = 5,000*11
55,000.00
Costs:
Direct Materials = 5,000*3
15,000.00
Direct Labour = 5,000*1.50
7,500.00
Variable Manufacturing Overhead = 5,000*.40
2,000.00
Variable Selling expenses = 5,000*1.30
6,500.00
Fixed Administrative Costs
15,000.00
Total Costs
46,000.00
Net Income from special Order = 55,000 - 46,000
9,000.00
Explanation / Answer
By doing CVP analysis, the management gets to know about the minimum quantity that is required to be sold in order to cover the total cost (variable as well as fixed cost) which is called break even quantity. Also, CVP analysis helps in tracing the sales required, over and above break even sales, to make maximum profit that management can earn by operating on the full capacity (margin of safety).This is explained by the example mentioned in the question in the following way:
Break-even sales: Total fixed cost / contribution ratio
= $15,000/43.64%
= $34,372
{Contribution ratio = (selliing price per unit-variable cost per unit)*100 /selliing price per unit
=($11-$6.2)*100/$11 = 43.64%}
Margin of safety: Total sales - break even sales
$ 55,000 - $34,372
= $ 20,628
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