One of the reasons for the justifiable popularity of CVP analysis
is that it’s fast. Let us build the logic step by step. Suppose you are considering
setting up your own clothing store and what appears to be an
ideal site has just become available to rent. You estimate you will need
$750,000 at the outset to fit out the store, fill it with inventory, purchase
equipment, and cover various other initial expenses. Is this an
opportunity worth considering? The answer to this question depends
on your ability to generate sales, and this is where CVP analysis comes
to the rescue.
The most common application for CVP analysis is to help identify
a planned sales figure. In order to achieve this, the technique can
be viewed as comprising three distinct stages. The first stage involves
establishing why you want sales in the first place. In other words, how
much would you like to earn? There are only two reasons any business
wants sales:
T To pay its regular expenses
A business will incur certain expenses regardless of whether sales
take place or not. These are its fixed costs and need to be paid.
T To make a profit
Businesses need to generate a profit to provide a return to their
investors.
In your clothing business you will have to pay fixed costs such as
rent, heating and lighting, telephone, salaries, and so forth. In addition,
you will want a return on the $750,000 you are planning to
invest. Suppose you estimate that your fixed costs during the first year
of trading will be $250,000. In addition, you would like to achieve a
profit of $150,000 (which represents a 20% return on your initial
investment of $750,000). We have now established that you would like
to have enough sales to
T Pay your annual fixed costs of $250,000
T Plus provide a profit of $150,000
is that it’s fast. Let us build the logic step by step. Suppose you are considering
setting up your own clothing store and what appears to be an
ideal site has just become available to rent. You estimate you will need
$750,000 at the outset to fit out the store, fill it with inventory, purchase
equipment, and cover various other initial expenses. Is this an
opportunity worth considering? The answer to this question depends
on your ability to generate sales, and this is where CVP analysis comes
to the rescue.
The most common application for CVP analysis is to help identify
a planned sales figure. In order to achieve this, the technique can
be viewed as comprising three distinct stages. The first stage involves
establishing why you want sales in the first place. In other words, how
much would you like to earn? There are only two reasons any business
wants sales:
T To pay its regular expenses
A business will incur certain expenses regardless of whether sales
take place or not. These are its fixed costs and need to be paid.
T To make a profit
Businesses need to generate a profit to provide a return to their
investors.
In your clothing business you will have to pay fixed costs such as
rent, heating and lighting, telephone, salaries, and so forth. In addition,
you will want a return on the $750,000 you are planning to
invest. Suppose you estimate that your fixed costs during the first year
of trading will be $250,000. In addition, you would like to achieve a
profit of $150,000 (which represents a 20% return on your initial
investment of $750,000). We have now established that you would like
to have enough sales to
T Pay your annual fixed costs of $250,000
T Plus provide a profit of $150,000
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