Cost Volume Profit Analysis For Better Economic Decision Making: A Literature Review

Literature Review

Cost volume profit analysis is a cost analysis method which is used in the organization to measure the impact of the cost on various level and production volume of the company. It measures that how the changes in the sales volume of the company affect the operating profitability level of the business. Cost volume profit analysis focus on the breakeven point at different sales level and cost structure of the business in order to make the short term economical decisions. cost volume profit analysis approach takes various assumptions in order to offer the relevant decision which includes the fixed cost, sales price, variable cost per unit etc. implementing the approach of cost volume profit analysis include various items in an equation such as cost, price and other variable that are mainly plotted on n economical graph (Richardson and Rothstein, 2008). In organizations, this approach is used by the companies to make better economical decision so that the overall performance of the business could be managed and the financial analysis process could be done on the business.

Malhotra and Temponi, (2010) has stated in their report that in smaller organizations, the management accounting process is often done by the entrepreneurs or the manager of the company which reduces the total cost of the business along with the significance in the opportunity cost of the business. However, it has been argued that the management accounting is a crucial process for an organization which must be evaluated and processed by the professionals so that the better base could be created to reach over economical decision. There are always different variations and different assumptions in order to make the economical decision for different size of organizations. If there is a larger organization than the management accounting process is always done by the professionals who measures and takes the assumptions on some solid basis so that the better conclusion could be made for the betterment of the business.

the definition of the small and medium enterprises totally depend on the analysis of operational and cost benefit approaches which has been adopted by the organizations in order to reach over a conclusion about the performance of the company. small sized organizations are those organizations which have lesser than 50 employees and the annual turnover of the business is not more than the EUR 10 million as well as the assets of the business should be lower than EUR 10 million (Darnall, Henriques and Sadorsky, 2010). Each of the country has different figure of assets, turnover and the employees but they are almost similar to each other. Further, medium sized organizations are those organizations which have lesser than 250 employees and the annual turnover of the business is not more than the EUR 50 million as well as the assets of the business should be lower than EUR 43 million.

In order to calculate the break even analysis of the company, it is quite important for the business to measure the fixed cost of the company firstly and then the study must be done on the selling price and the variable cost of the business. The difference among the selling price and the cost of a product is recognized as the contribution margin in the business. contribution margin is calculated along with the total fixed cost of production of the company in order to measure that how much units must be sold out by the company in order to reach ever the point where the revenue of the business has cover the total expenses of the business (Jansson and Sandberg, 2008). It also defines about the total dollar amount which must be generated by the business through its normal operation in order to meet the expenses of the business.

Once the breakeven level is achieved by the company, it becomes easier for the business to reach over the margin of safety point which describes about the total profitability level of the business. Variable cost is the cost which gets change along with the changes in the sales unit and the level of activities. Variable cost only takes place in an organization when the production activities are carried. The variable cost per unit of the company does not get change along with the changes in the sales unit of the company. Further, the fixed cost is the total cost which does not get change along with the changes in the sales unit and the level of activities (Misra and Mondal, 2011). Fixed cost takes place in an organization at the time of planning of production. The total fixed cost of the company does not get change along with the changes in the sales unit of the company.

Some of the cost in the business is hard to recognize that whether they are the fixed cost or the variable cost of the company such as the advertising cost of the business. A business treats this cost according to their policies and nature of organization. The common treatment of such kind of cost is to consider half of the cost as variable cost and rest cost is treated as fixed cost of the business (Tri, Hoai, Huu and Thu, 2016). Break even analysis is planning tool which is used by the managers and the organizations to idneitfy the point where the total expenses of the business could be cover by the business.

Cost volume profit analysis is a management accounting analysis method which is used in the organization to measure the impact of the production cost, fixed cost and variable cost on different sales level of the company. It measures that how the changes in the sales volume of the company affect the operating profitability level of the business. It basically measures the breakeven point of an organization at different sales level and cost structure of the business in order to make the short term economical decisions (Pangarkar, 2008). The approach of break even analysis takes various assumptions in order to offer the relevant decision which includes the fixed cost, sales price, variable cost per unit etc. Implementation of this approach includes various items in an equation such as cost, price and other variable that are mainly plotted on n economical graph.

the study of break even analysis has been done on the small and medium enterprises and it has been measured that there are always few differences among both of the organization type because of the product costing, standard costing, budgets for the planning and control over the expenses, responsibility accounting etc. companies take the help of break even analyse to make the decision about the short term economical decision. It is required for both small and medium size enterprises to evaluates few of the items and make the decision about the economical and financial decision of the company but along with that, it is also important for the different size businesses to measure the different aspect to reach over a better conclusion about the economical and financial position of the business (Rosenthal and Strange, 2010).

In small enterprise, the management accounting process is often done by the entrepreneurs or the manager of the company which reduces the total cost of the business along with the significance in the opportunity cost of the business. But it has been found that these managers or the entrepreneurs are not much aware about the management accounting concepts and thus the findings made by such enterprises affect the performance of the company and they could not make the better decision about the business analysis and cost volume profit analysis. However, few of the enterprises have started showing the interest to hire the management accountant in order to maintain the control over the accounting and financial activities of the business and make better conclusion about the performance of the company (Nichter and Goldmark, 2009). It has been belied by the short term enterprises now that the better evaluation by the professionals offer the entire process and performance of the business and it also become easier for the business to identify the main root of failure of the business.

Further, in case of medium sized enterprise, it has been analyzed that the break even analysis approach is followed by the company in a significant manner so that the overall performance of the business could be improved. In the medium size enterprises, the management accounting process is often done by the professionals and the management accountant of the company which somehow improves the total cost of the business. But it has been found that these accountants are much aware about the management accounting concepts and thus the findings made by these people improve the performance of the company and they help the business to make the better decision about the break even analysis and cost volume profit analysis (Jansson and Sandberg, 2008). However, it has also been found that the management accountant must be very much dedicated towards their work. because of their lack of knowledge and dishonest, the control over the accounting and financial activities of the business get affect and due to it, the company get fail to make better conclusion about the performance of the company. It has been believed by the medium term enterprises that the better evaluation by the professionals offer the entire process and performance of the business and it also become easier for the business to identify the main root of failure of the business.

CIMA (2018) has further added in their study that there are always three management accounting tool which must be consider by each type of enterprises while evaluating the financial information and making the decisions about the economical and financial benefits of the company. It was among the best findings of the study which explains that the internal cost volume profit analysis, working capital measurement and the product cost or service cost analysis is important for each of the business. These factors make it easier for the business and the internal stakeholders of the company to make better decisions about the performance and overall position of the business. Small medium enterprise often lack understanding or knowledge about their result and the cost which helps them to take the decision about the product mix or improves the decision process of the business. Along with that, it has also been recognized that in smaller enterprises, it becomes tough for the managers and owners to identify the requirement of the working capital and the management of the working capital.

In the same case, the study has been performed on the medium sized enterprises of the business, and it has been found that the understanding or knowledge of managers about their financial and economical result are quite better and the accountants also evaluates the cost which helps them to take the decision about the product mix or improves the decision process of the business (Van de Vrande, De Jong, Vanhaverbeke and De Rochemont, 2009). Along with that, it has also been recognized that in medium enterprises, it becomes quite easier for the managers and owners to identify the requirement of the working capital and manage the working capital.

CIMA (2018) has performed a research on few small and medium size enterprises in order to measure that how both of the type of enterprises affect differently and follow the management accounting concept differently. through the research, it has been measured that the main management accounting tools of an organization are predict costing, break even analysis, Cost volume profit analysis, working capital measurement, formal budgets and the responsibility accounting. Through the evaluation on all of these measurement on small and medium enterprises, below results have been achieved:

(CIMA, 2018)

The most significance difference among the small and medium size enterprises is that the management accounting concept is followed by each of the organization differently in order to get the similar result. Through the evaluation on the above table, it has been found that the different management accounting concept is used by the different companies in order to reach over the conclusion and improve the overall performance of the company. Small size enterprises might not need the entire accounting concept as the activity area of the company is quite smaller and the owners feel that they could manage the entire process at their own. But in case of the medium size enterprises, the organizations required all the accounting concept as the activity area of the company are higher and it is important for the business to measure all the factors in order to make better decision about the business (Liedholm and Mead, 2013).

Further, it has been studied that the aspect and the area of decision of both the enterprises are different and because of that, they use the different accounting approaches on the basis of need and the requirement of the business. small size enterprises have limited funds and thus they do not wish to spend huge amount on the approaches and the people which are actually not required in the business, whereas, if the medium size enterprises are taken into the concern, than there are huge funds available for the business to run the activities and operations of the company smoothly (Ahlin, Lin and Maio, 2011). And thus they are required to hire accountant and spend amount on the approaches so that the better decision could be made in the business and the overall performance of the business could be improved.

Conclusion:

the findings over the small size enterprises and medium size enterprises and cost volume profit analysis explains that there are huge difference among both the enterprises types because if the management accounting concept and the professional people availability, however, it has also been found that huge changes have occurred into the small size enterprises in current market because of the market changes and the demand of the market. Though, it has been found that the management accounting concept are still followed by the owners of the enterprises but it has also been found that they are using the proper calculations and method to evaluate the total units which must be sold in the market to reach over a better conclusion and improve the economical and financial performance of the business.

improvement of awareness in the SME has improved the decision support tools which includes the relevant cost analysis, appraisal techniques, capital expenditure etc. the scope if the basic toolkit has also been improved in the SME as in order to survive in the market and maintain the overall position of the business in the market. finally, it has been concluded that the small size and medium size organizations approaches and the way of handling the approaches are different which rises a big difference among both the organizations.

References:

Ahlin, C., Lin, J. and Maio, M., 2011. Where does microfinance flourish? Microfinance institution performance in macroeconomic context. Journal of Development Economics, 95(2), pp.105-120.

CIMA. 2018. Management Accounting Practices of (UK)

Darnall, N., Henriques, I. and Sadorsky, P., 2010. Adopting proactive environmental strategy: The influence of stakeholders and firm size. Journal of management studies, 47(6), pp.1072-1094.

Jansson, H. and Sandberg, S., 2008. Internationalization of small and medium sized enterprises in the Baltic Sea Region. Journal of International Management, 14(1), pp.65-77.

Liedholm, C.E. and Mead, D.C., 2013. Small enterprises and economic development: the dynamics of micro and small enterprises. Routledge.

Malhotra, R. and Temponi, C., 2010. Critical decisions for ERP integration: Small business issues. International Journal of Information Management, 30(1), pp.28-37.

Misra, S.C. and Mondal, A., 2011. Identification of a company’s suitability for the adoption of cloud computing and modelling its corresponding Return on Investment. Mathematical and Computer Modelling, 53(3-4), pp.504-521.

Nichter, S. and Goldmark, L., 2009. Small firm growth in developing countries. World development, 37(9), pp.1453-1464.

Pangarkar, N., 2008. Internationalization and performance of small-and medium-sized enterprises. Journal of world business, 43(4), pp.475-485.

Richardson, K.M. and Rothstein, H.R., 2008. Effects of occupational stress management intervention programs: a meta-analysis. Journal of occupational health psychology, 13(1), p.69.

Rosenthal, S.S. and Strange, W.C., 2010. Small establishments/big effects: Agglomeration, industrial organization and entrepreneurship. In Agglomeration economics (pp. 277-302). University of Chicago Press.

Small-Medium-Sized Enterprises (SMEs). (online). Accessed from: https://moodle.bolton.ac.uk/pluginfile.php/698586/mod_resource/content/1/ManagementAccountingPracticesOfSmall-Medium-SizedEnterprises.pdf (accessed 13/11/18).

Tri, H. T., Hoai, V. Huu, T. and Thu, H. 2016. Break-Even analysis in business for small and medium enterprises: study in GIA LAI PROVINCE – VIETNAM. (online). Accessed from: https://msed.vse.cz/msed_2016/article/291-TriTang-Hung-paper.pdf (accessed 13/11/18).

Van de Vrande, V., De Jong, J.P., Vanhaverbeke, W. and De Rochemont, M., 2009. Open innovation in SMEs: Trends, motives and management challenges. Technovation, 29(6-7), pp.423-437.

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