Financial Decision Making for CVP Analysis -Methods Of Calculation

Question: Discuss about the Financial Decision Making for CVP Analysis. Answer: Introduction: Primarily, CVP analysis looks into the activity level of differing financial outcomes of a business. The reason behind the particular focus on the sales volume of travel and tourism industry in UAE is, in short-run the cost of labours, materials and sales price is generally known with the accuracy degree of accuracy. In the short-run sales volume cannot be predicted correctly, therefore, profitability is considered for this (Kumar 2016). Managers are worried about the effect of their decisions on profit. The decisions they make are about pricing, volume, or incurring the expenses. Therefore, managers need an understanding of the relations among revenues, volume, costs and profit. The cost accounting sector supplies the data and analysis, called cost-volume-profit (CVP) analysis that helps these managers to make decisions. CVP analysis facilitates managers to estimate the effect of alternative pricing strategies of product on profits. It can also be used to estimate pricing strategies of competitors and efforts to grow the market share (Tan 2013). Methods of calculation: The margin of contribution is equal to total revenue less total variable cost. In other words, the unit of contribution is selling price per unit less variable cost per unit. It can be formulated as: (USP*Q) (UVC*Q) FC = P Or, Q(USP UVC) =FC + P Or, Q = FC+P UCM Here, USP = Unit selling price, UVC = unit variable cost, UCM = unit contribution margin, Q = quantity, FC = Fixed Cost and P = Price An organizations cost composition is the proportion of variable costs and fixed cost to total costs. Airline industries such as Emirates airline of United Arab Emirates needs large investment in equipment, which results in involvement of high fixed costs. On the other hand, grocery retailers need higher amount of variable costs. Airline industrys cost structure has a substantial effect on the sensitivity of its profits to volume change (Samuels and Sawers 2015). The airline industry in the UAE, such as Emirates Airline have high fixed equipment, labour and other costs and which operate using a hub system. Newer carriers, like Air Arabia, Flydubai have lower labour costs and operate out of lower cost and less-congested airports. The higher the fixed costs, the higher the break-even point. Once the break-even point has been reached, profit starts increasing at a high rate (Datar et al. 2013). Limitations and decision-making: From the above discussions, it can be concluded that, CVP analysis relies on certain hypothesis and these hypothesises may limit the applicability of the outcomes for decision-making. It is important to understand, that the limitations are due to the estimates that the cost analyst makes. However, these estimates are simplifying the assumptions that are made by the analyst. If the unit prices are lower for higher volumes that relation can be incorporated into CVP analysis. The lesson from this is that CVP analysis is a tool that the managers use for decisions-making purpose. The more crucial the decision, the manager will want more to assure that the estimates made are applicable. Moreover, if the decisions are sensitive to the assumptions made (for example, that prices do not depend on volume), the manager should be cautious about depending on CVP analysis without considering alternative assumptions. References: Datar, S.M., Rajan, M.V. and Horngren, C.T., 2013.Managerial Accounting: Decision Making and Motivating Performance. Pearson Higher Ed. Kumar, R., 2016. Break Even Analysis: A Glance.International Journal of Research in Finance and Marketing,6(2), pp.175-193. Samuels, J.A. and Sawers, K.M., 2015. Arizona Microbrewery, Inc.: An Instructional Case on Management Decision Making.Issues in Accounting Education. Tan, K., 2013. An Income Statement Teaching Approach for Cost-Volume-Profit (CVP) Analysis by Using a Companys CVP Model.Journal of Accounting and Finance, v. 11, no. 4, p. 23-36.