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.
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