Importance Of Profit-Cost-Volume In Planning

Importance Of Profit-Cost-Volume In Planning

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Importance Of Profit-Cost-Volume In Planning

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The profit cost volume defines an analytical tool used to study the relationship that exists between profits, prices, costs and volume. To an extent, the profit cost volume analysis is a part of, and to an extent it can even be expressed as an extension of marginal costing (Gandoura, 2017). It is a crucial part of the profit-planning of a company. Whereas the formal profit control and planning makes use of forecasts such as budget, the profit cost volume approach provides only the profit planning process overview. In addition, the approach assists in the evaluation of the reasonableness and purpose of these forecast and budgets (Layne, 2004). The profit cost volume analysis is useful as a managerial tool because it offers an insight into the interrelationships as well as effects of factors influencing the firm’s profits. The relationship among the profit, volume, and cost makes up the profit model of a firm. Thus, the profit-cost volume relationship becomes crucial in profit planning and budgeting.

As it is involved principally in profit planning, it assists in determining the maximum volume of sales so as to avoid losses (Gandoura, 2017). Further, it can be used to find the volume of sales under which the organizational profit goals have to be accomplished. Further, as an ultimate objective it assists in helping the management to come up with the most profitable combination of volume and costs. As a dynamic management tool, therefore, the profit cost volume is used to evaluate and predict the consequences of a firm’s short run decisions with regard to the selling price, sales volume, marginal cost and fixed costs for the continuous profit plans. In general, the profit cost volume analysis offers answers to the following questions which can be termed as the pillars of profit making and planning;

• Which is the most profitable product and which product should be discontinued
• What are the minimum volumes of sales have to be affected so as to avoid losses and
• What will be the effects of changes in volume, cost and prices on profits

Variable Costing -Article summary

This a term that defines the methodology which only assigns variable costs to inventories. Variable costing translates to the fact that all the overhead costs, in the period incurred are charged to the expenses while the variable overheads costs as well as the direct materials are assigned to the inventory. According to (Kristensen, 2020), in financial reporting, there are no applications of variable costing because the accounting frameworks for example the GAAP and the IFRS, expect that overheads be allocated onto the inventory. Variable costing has its only one application in internal reporting purposes. In the internal reporting purposes, the variable costs are used in;

• Formulating the internal financial statements into a format of contribution margin
• Establishing the lowest possible prices within which the products can be sold
• Conducting breakeven analysis in order to establish the sales levels within which an enterprise will earn zero profits.

Further, (King, 2006) outlines that when the variable costing is applied, the reported gross margin from revenue generating transactions are higher compared to the absorption costing systems. This is because the overhead allocations are charged to the sales. Even though this doesn’t mean that the gross margin reported is higher, it doesn’t mean that there are higher net profits. In essence, (King, 2006) states that it’s because the overhead is charged in the income statement to the expense lower, instead. However, (Drury, 1992) goes on to state that it’s only in cases where the production levels match the sales. Thus, if sales fall below production, the absorption costing will lead to higher profitability levels because several of the allocated overhead resides in inventory asset as opposed to being charged in the period expense. Thus (Drury, 1992), states that the reverse situation will only occur once sales have exceeded production.

Importance Of Profit-Cost-Volume In Planning

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