Week 4: CVP Analysis & limiting factors Flashcards
What is CVP Analysis?
Study of the relationship between costs, sales and profit
e.g. what will happen to financial results if a specified level of activity or volume fluctuates?
What are the implications on profit following (hypothetical) changes in costs, sales output or prices.
Evaluate the profitability implications of alternative decisions or “uncontrollable” situations (i.e., “What if” questions).
The behavior of different production costs considered: the “fixed vs. variable” costs classification is critical.
what are the main characteristics of linear CVP relationships?
In Linear CVP relationships:
Constant variable cost and selling price is assumed.
Only one break-even point and profit increases as volume increases.
Cost and revenue behaviour only within the relevant range of output:
Costs are linear and can be accurately divided into variable and fixed components
.
The variable costs are constant per unit and the fixed costs are constant in total over the entire relevant range.
In multiproduct companies, the mix of products sold remains constant.
what is the high to low method?
High-Low Method is the high-low method is a way of attempting to separate out fixed and variable costs given a limited amount of data.
Difference from highest (800) to lowest (450) = (£4750 – 3000) / (800-450) = £5 per unit (variable element). Fixed element = £4750 – (800 units x 5) = £750
For 900 units, the total cost will be £750 + (900 units x £5) = £5,250.
What is Operating leverage?
Operating leverage is The proportion of fixed and variable costs may have a significant impact on profits.
Operating leverage is used as a measure of the sensitivity of profits to changes in sales.
Degree of operating leverage = Contribution margin / Profit
how do you choose which product to make when there are scarce rescourses?
The product generating the highest contribution per scarce resource ratio will normally have priority
if there are more than one rescoruce constraint how do you solve it?
If more than one constraint - use linear programming.
LP is a mathematical technique that seeks to maximise the profits or minimise the costs - objective function
what are the Steps involved in solving a linear programming problem?
Steps involved in solving a linear programming problem:
Determine the objective function
Specify the constraints
Calculate the optimal solution using a graphical approach or use the simultaneous equations to determine the optimal solution in complex situations
Calculate the contribution and profit at the optimal solution.
what are the Problems in Applying Linear programming?
Problems in Applying LP:
Objective function assumes a constant contribution per unit of output, regardless of the level of activity;
Assumes that all costs either vary with a single volume-related cost driver output measure or they are fixed for the period under consideration.
Assumes that output and use of resources are perfectly divisible.
