Cost volume profit analysis – are useful to start-up business, launching new product, reducing the cost, increasing the selling price and calculating the impact in the business. It answers the ff: questions How much I need to sell to achieved the target income?
How will income be affected if I reduce the selling price to increase sales volume?
What will happen if I expand the capacity of the plant?
Classification of Costs
Fixed costs – remains the same even if the activity or volume of activity level changes. Per unit remains the same as the activity level changes
Variable costs – changes as the activity level changes, per unit changes as the wide ranges of activity level changes
A limited range of activity called the relevant range where cvp relationships are linear
a. unit selling price remains constant
b. unit variable cost remains constant
c. total fixed cost remains constant
Sales mix remains constant
Production= sales (no inventory changes)
Time value of Money
The pound today is worth more than the pound tomorrow. The prices of goods continually change. The effects of inflation: rate at which prices increasing e.g 105 with 5% inflation rate.. The purchasing power of money eroded. The opportunity cost or the foregone costs that you can use the money today instead of spending it you should invest .
Capital Investment Appraisal
- associated with management accounting decisions. Part of the budget cycle as it is concerned with the commitment of funds in anticipation of being able to earn future stream of funds.
- It illustrates different methods that can help decision making and it assumes the option choice for the organization
- Usually associated with large projects
- Involves expenditure for the benefit of future cash flows
- Most of us need to decide which competing projects to choose wether in a large or small scale
- Need to understand the basis of flow for proposals are put together especially as to the criteria for selection or approval
- Enables an understanding of the methods used or issues involved in investment appraisal
- It helps in the investment decision making and it involves some qualitative and quantitative data can be important issues such as non reliable supplier
- Relates to forward looking context
- One off decisions
- Net cash flow approach
- Data availability
- Opportunity cost
- Probability testing
Factors influencing the returns required by investors from a project
The payback period
Is the length of time it takes to recover the amount of investment, or the length of time to recover the initial amount of investment to be repaid out of the net cash inflows from the project.
Advantages and disadvantages
It is simple to use and understand but it is also problematic
It focus on manager opinions on time to payback with the focus on cash payment recovery.
The total cost of investment is ignored as the criteria of selection is payback time
It ignores cash inflow after payback period
Ignores the timing of actual cash inflow
Accounting Rate of return
- it used the accounting profit instead of cash inflows. It is similar to ROCE both emphasized profit and investment.
- Formula Average Profit less depreciation / Average Investment
- it might not be reliable because of the accounting environments due to tax implications and accounting policies to arrive at the accounting profit.
Internal Rate of return
It is related to NPV
The IRR is...