Agriculture Reference
In-Depth Information
Assumptions of volume-cost analysis
As the manager begins to utilize the breakeven calculation, it is important to understand the
assumptions made for the breakeven procedure. These assumptions are:
1.
Fixed costs are constant
2.
Effi ciency is unchanged
3.
Input prices are fi xed
4.
Product mix is constant
5.
Selling price is unchanged
The fi rst assumption listed above relates to
Figure 12.1.
By defi nition, fi xed costs are con-
stant over the operating period. Any decision made, such as the purchase of a new piece of
equipment, will change fi xed costs and, thus, the breakeven level. The second assumption
relates both to fi xed and variable costs. The manager assumes the fi rm is at a specifi c point
on the average fi xed-cost curve,
Figure 12.2,
and the fi rm cannot reduce per unit variable
costs, for example, by taking advantage of volume discounts from suppliers. If effi ciency
can be increased in some way, a new breakeven level must be calculated.
The third assumption relates to
Figure 12.4
where the variable costs of inputs are shown
to be a constant percentage of sales. If suppliers or the fi rm does anything to alter input costs,
breakeven changes. The fourth assumption is one that is often overlooked. In a diversifi ed
fi rm there are revenues and costs from several different product categories. Some of these
product divisions may have signifi cantly higher percentages of variable costs. Thus, as the
fi rm sells relatively more of this product, the total variable costs for the fi rm shift. Hence,
one makes the assumption of a constant product mix, which means the percentage of sales
from each division or department is fi xed. The fi nal breakeven assumption is straightfor-
ward. Basically, anytime a fi rm changes selling price, it also changes the contribution margin.
Thus, if prices change, breakeven must be recalculated.
Uses of volume-cost analysis
Profi t planning
Volume-cost relationships are useful for much more than just calculating the breakeven
point. They can also be used to determine the volume of business necessary to generate cer-
tain levels of profi t, which is an essential part of profi t planning.
Since revenue above variable costs is profi t once the overhead has been covered, a similar
calculation can be used to determine the additional sales necessary to reach a given profi t
level. If BF&G has a net operating income (after interest) goal of $250,000, it will take an
additional $2,413,127 sales above their breakeven volume of $11,097,703 to achieve the
profi t goal. The additional sales needed to accomplish that goal is calculated as shown
below:
Profit Goal
CTP
Additional Sales to Reach Profit Goal
=
$,
250 000
0 1036
=
$,
2 413 127
,
.
