To begin with we would like to provide some background information about the case under consideration. Long & Associates (L&A) is looking for innovative employees who engage with their work. This is an organization with rapidly growing sales and expanding customer acceptance in the surf wear clothing target market 18-30 years.
The clothing is sold under an increasingly recognized brand name worldwide. Sales are made online -both internationally and locally, as well as through franchised outlets. The accounting system has not kept pace with the growth and complexity of the company. It is even more critical for the company to take control of its finances in the current slow recovery of the U.S. and European markets.
Issue 1. The management wants to be able to predict the effect on profits resulting from changes in volume, costs and prices.
In our opinion, the best method to see correspondence between costs of production and profits is the so-called cost-volume-profit analysis. To begin with we would like to provide a definition of the term “cost-volume-profit analysis”. In our opinion, one of the best definitions of this term is the following. “Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point (BEP), a company will experience no income or loss. This BEP can be an initial examination that precedes more detailed CVP analyses” (Cost-Volume-Profit Analysis).
In other words, the cost-volume-profit analysis shows how the changes in volume of production affect the costs and profits. More specifically, it shows how the following factors affect the profits: variable costs, fixed costs, selling prices, volume of production and mix of the sold products.
This type of analysis is based on the following principles and assumptions:
The costs of production are classified as fixed or variable;
All the produced units are sold;
The costs of production can be affected only by the changes in production activity;
The sales mix remains constant even when a company sells more than a one type of product.
This type of analysis is a little bit broader, than a breakeven analysis. As you probably know, breakeven analysis shows the volume of production and the selling price, when a company’s profits are equal 0. Thus, it shows when all the costs are compensated.
Cost-volume-profit analysis provides a company’s managers with more detailed information. For example, it lets answer the following questions: what sales volume is required to reach a desired level of profits? How would changes in the selling prices affect the profits of a company? How would the changes in the mix of products sold affect the target profits?
A formal definition of the term “breakeven analysis” can be the following. “Breakeven analysis is an analysis to determine the point at which revenue received equals the costs associated with receiving the revenue. Break-even analysis calculates what is known as a margin of safety, the amount that revenues exceed the break-even point. This is the amount that revenues can fall …