capital budgeting decision

capital budgeting decision

Cost volume profit relationship is an analysis that is utilized by an organization to aid in effective understanding of the interlinkages between the costs, sales as well as the returns or profits of the organizations. The tool is essential since it assists the organization in attaining the profit maximization goals of the organization, which emphasis on minimizing on the cost of inputs and maximizing on output (Karabatsou & Tsironi, 2016). The analysis hence is usually conducted with the primary objective of establishing how the costs, prices, fixed and variable costs impacts on the profits for the organization. Cost volume and profit analysis also emphasis on the concept of breakeven point, which is the point at which the total revenue equals the total indicating that the business is nether making profit nor losses. This tool is essential since it assists the managers in forecasting about the expected future demand and sales volume for the organization. This is essential since it assists the organization to continue with its operations as a going concern concept in the competitive environment. Cost profit and volume analysis tool assist the management in effective planning which results to the effective formulation of viable policies for the organization such as internal controls as well as enhancing effective decision making by the organization (Karabatsou & Tsironi, 2016). The decision formulated they include capital budgeting decision among others which essential in determining the organization ability to continue with its operations in the competitive environment.

Numerical illustration

XYZ Company intends to purchase a motor vehicle worth $50000. The new vehicle will assist the company in producing finished goods which can be sold at $50 with variable costs of 25. Determine breakeven point using CVP approach

Breakeven point = Fixed cost/ (SP – VC)

= 50000/ (50-25) = 2000

This indicates that the company should sell approximately 2000units to breakeven and start making profits.

Variable costing is an approach which assigns variable costs to the inventory. The overheads incurred within the period hence are charged to expenses while variable overheads and materials are charged to inventory. The tool hence is essential in establishing sales volume that will assist the entity in attaining breakeven even point. This is imperative since it assists in establishing whether the business will continue in business as a going concern (Dyhdalewicz, 2015). The tool assists in determining the contribution margins as well as the breakeven point for the company in the competitive environment. The tools assist management in formulating policies and making of decision that affects the organization performance and productivity. The tool also assists in profit planning and cost controls which are the primary roles for the managers with the organization.

Suppose ABC Company intends to produce the product at the cost of $25, the production of the product it will require $10 raw materials, $6000 fixed costs and $15 labour. Determine the costs of making 50 units using variable costing approach of $25*50= $1250 this will be variable cost, fixed cost of $6000. Assuming the selling price for the product is $75. Determine how many units are required to breakeven, which will be 6000/ (75- 25) = 120units.

Hi Praveen Javvaji,

Cost profit volume approach focuses on establishing the effects of the varying costs on the expected volumes within the organization. This is essential in establishing whether the business is operating profitably. The organization are usually required to minimize the cost of inputs while maximizing on the final outputs. This is essential since it assists the company to succeed in the ever-changing environment (Karabatsou & Tsironi, 2016). The tool is essential in determining breakeven point, which is essential since it determines the period at which the business will start making profits which is the primary goal for establishing the business. Variable costing on the hand requires the organization to assign variable costs to inventory. The approach is essential in ensuring profit planning and cost control. This is essential in establishing business continuity in the competitive environment. Embracing these approaches is vital since it contributes to the attainment of higher performance and productivity.

Hi Pradeep Saranga,

The organization operates in a competitive environment which poses both opportunities and threats to the organization. The organization hence are required to embrace the best costing mechanism to breakeven and remain in business. Cost volume profit approach, this approach is essential in determining the impacts of the cost and volumes of the expected outputs for the organization with regards to the expected profit. The tool is vital since it assists the management in establishing whether the company is generating sufficient returns (Karabatsou & Tsironi, 2016). Higher profits indicate that the business is liquid, and is able to honour its obligation when they fall due. This enables the organization to survive stiff competition and be able to command a high market share. Variable costing emphasis on assigning variable costs to inventory as well as to variable costs and direct material. The approach is essential in establishing a breakeven point as well as determining the contribution margin. This is vital since they assist the management in establishing whether the business is operating in a profitable manner.

Hi Devadas Tenali,

The primary goals for establishing an organization is to generate profits. This requires the organization to have effective costing approaches to aid in attaining the profit maximization goals. The commonly approaches for costing they include cost-profit and volume approach and variable costing. The CVP approach focuses on how the organization controls the costs, prices etc. in the attainment of the profit maximization goals for the organization, which is the primary purpose for establishing the organization. Variable costing on the hand focuses on assigning a variable cost to the inventory(Dyhdalewicz, 2015). Variable cost is the one which varies with the output of the organization. The tool hence assists in establishing the contribution margin and breakeven points. These are essential in determining whether the organization will continue with its operations in the competitive environment. The tools assist the management in formulating strategic decision that influences the whole organization operations, and they determine the success of the organization in the ever-changing environment.