Importance of cost volume profit analysis?

Answer 1

Importance of Cost Volume Profit (CVP) Analysis:The most profitable combination of variable cost, fixed cost, selling price and sales volume can be found with the help of cost volume profit analysis. If fixed costs can be reduced by a greater amount, the profits can sometimes be increased by reducing the contribution margin.

More commonly, however, we have seen that the way to improve profits is to increase the total contribution margin figure, Sometimes this can be done by reducing the fixed costs (such as advertising) and thereby increasing volume; and some times it can be done by trading off variable and fixed costs with appropriate changes in volume. Many other combinations of factors are possible.

The size of the unit contribution margin (and the size of the contribution margin ratio - CM ratio) is very important. For example, the greater the unit contribution margin, the greater is the amount that a company will be willing to spend to increase unit sales. This explains in part why companies with high unit contribution margin (such as auto manufacturers) advertise so heavily, while companies with low unit contribution margin (such as dishware manufacturers) tend to spend much less for advertising.

In short, the effect on the contribution margin holds the key to many decision.