Production Management

The Nature and Importance of Cost-Volume-Profits Relationship

The concept of Cost-volume-Profit Relationship – The cost of population depends to a large extent on the volume of production and product-mix, whereas, the profit of the enterprise depends upon the cost of production and sale price. Thus, there is a direct relationship among three factors-cost,- volume of production and the profits of the concern. Thus, cost-volume profit analysis attempts to determine the effect that a change in the volume, cost, price and product-mix will have on profits. In other words, it stresses the relationships among the factors affecting profits.

The management is always interested in finding out which product or product-mix is the most profitable, what effect a reduction in sales price will have on the final profit, what effect a change in the volume of output will have on the cost of production and profit, etc. All these problems are solved with the help of the cost-volume profit analysis. Thus, this analysis is a means of showing the relationship between those variables which form die basis of profit-planning. It is also known as Break-even Analysis.

Importance of Cost-volume-profit analysis

The study of cost-volume-profit relationship is very significant for the management. Whenever the management is to choose the best alternative from a number of alternatives, this analysis helps it very much. This analysis is very useful in planning, as well as in controlling the business activities. It is only through the use of this analysis that the prediction of the probable effect of any contemplated action is made possible. This analysis is very helpful in budgeting and profit-planning also. Here are some of its uses :

(1) Calculation of profit for different sales volumes.

(2) Calculation of sales volume to produce desired profit.

(3) Calculation of selling price per unit for a particular break-even point.

(4) Calculation of sales volume needed to meet proposed expenditures.

(5) Determination of Margin of Safety.

(6) Calculation of sales needed to offset price-reduction.

(7) Measurement of effect of changes in factors.

(8) Choosing the most profitable alternatives.

(9) Determining the optimum sales-mix.

(10) Deciding upon the change in capacity.

(11) Contemplating the increase or decrease in profits due to the change in methods of production, etc.

Thus, we see that cost-volume-profit analysis is a useful tools in the hands of management. It helps the management in determining the most profitable price for the products. It helps the management in the optimization of profit and maximum utilization of resources. In brief, this analysis provided a fillip to the management to accelerate the volume of production to earn maximum profit.

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