Page 262 - DMGT403_ACCOUNTING_FOR_MANAGERS

Unit 12: Marginal Costing and Profit Planning

The relationship between two or more of these factors may be (a) presented in the form of Notes
reports and statements (b) shown in charts or graphs, or (c) established in the form of mathematical
deduction.

12.4.1 Objectives of Cost-Volume-Profit Analysis

The objectives of cost-volume-profit analysis are given below:
1. In order to forecast profit accurately, it is essential to know the relationship between
profits and costs on the one hand and volume on the other.

2. Cost-volume-profit analysis is useful in setting up flexible budgets which indicate costs at
various levels of activity.
3. Cost-volume-profit analysis is of assistance in performance evaluation for the purpose of
control. For reviewing profits achieved and costs incurred, the effects on cost of changes in
volume are required to be evaluated.
4. Pricing plays an important part in stabilising and fixing up volume. Analysis of cost-
volume-profit relationship may assist in formulating price policies to suit particular
circumstances by projecting the effect which different price structures have on costs and
profits.
5. As predetermined overhead rates are related to a selected volume of production, study of
cost-volume relationship is necessary in order to know the amount of overhead costs
which could be charged to product costs at various levels of operation.
12.4.2 Profit-Volume (P/V) Ratio

The ratio or percentage of contribution margin to sales is known as P/V ratio. This ratio is
known as marginal income ratio, contribution to sales ratio or variable profit ratio. P/V ratio,
usually expressed as a percentage, is the rate at which profits increase with the increase in
volume. The formulae for P/V ratio are:
P/V ratio = Marginal contribution/Sales
Or
Sales value - Variable cost/Sales value
Or
1 - Variable cost/Sales value
Or
Fixed cost + Profit/Sales value
Or

Change in Profits/Contributions/Changes

A comparison for P/V ratios of different products can be made to find out which product is more
profitable. Higher the P/V ratio more will be the profit and lower the P/V ratio, lesser will be
the profit. P/V ratio can be improved by:
1. Increasing the selling price per unit.
2. Reducing direct and variable costs by effectively utilising men, machines and materials.
3. Switching the product to more profitable terms by showing a higher P/V ratio.

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