COST PROFIT VOLUME ANALYSIS AS A CATALYST FOR MANAGEMENT PLANNING, CONTROL, AND DECSION MAKING OF MANUFACTURING COMPANY

CHAPTER ONE

INTRODUCTION

1.1. BACKGROUND TO THE STUDY

The success of a business is generally attributable in great measure of the ability of its management personal to cope with probable conditions of the future. Short-range as well as long-term plans must be made accomplished through sound management evaluation and good decisions. Management has been defined as a process of planning, controlling, organizing, directing and coordinating the affair of an organization. This process demand decision making at every stage. Where there are a problem and choice of action not just to the satisfactory of management but for the optimal goods of the firm.  This optimal choice provides a solution to the problem. The data provided must be used in reaching or deciding an end. In reaching this end, there is a powerful tool for planning and decision making that is required which is cost volume profit analysis. Cost volume profit analysis (CVPA) is a systematic method of examining the relationship between change in activity and change in total sales revenue, expenses and net profit. “Some industries today are encountering problems raised by expansion through increased sales and the introduction of new products. Many on the other hand are facing the problem of contraction due to the introduction of substitute materials, products. Whenever is the case, it is vitally important that management should be in a clear position to plan for these changing levels of activity”, In order to solve the problem created by the above situation profit planning, cost, and decision making require an understanding of the characteristics of costs and their behavior at different operating levels. One of the most important tools developed by accountants to assist management in meeting the challenges is the cost volume-profit-analysis (C.V.P) otherwise known as the behavior analysis. Cost volume profit analysis is a management tool used when the problems of CVP implications arise in the firm, the problem includes to make or buy decisions, product appraisal, add or drop decisions product planning and promotional mix, distribution channels and profit planning decisions. Cost volume profit analysis serves as an indispensable aspect of management decision making because it enables Managers of this manufacturing company to estimate future revenues, costs, and profits to help them plan and monitor operations. They also use cost-volume-profit (CVP) analysis to identify the levels of operating activity needed to avoid losses, achieve targeted profits, plan future operations, and monitor organizational performance. Managers also analyze operational risk as they choose an appropriate cost structure. The researcher notices that the output of a firm is restricted to the current operating capacity in the short run. This input can be increase other cannot, but it takes time to expand the capacity of plant and machinery. This output is limited in the short run because plant facilities cannot be expanded which enables a firm to take time to reduce its capacity. A firm must operate on a relatively constant stock of production resources because most of the costs and prices of a firm product will have already been determined, and the major area of uncertainty will be the sale volume. The researcher also notices that profitability will, therefore, be most sensitive to sale volume in the short run. Hence, cost volume profit analysis thus highlights the effects of changes in sales volume on the level of profit in the short run. CVP Analysis is also one of the tools that could be applied to identify organization targets of opportunity or potential areas of weakness by matching the organization breakeven. Though organizational management has a goal of maximizing their wealth, however, given that no obvious, single course of action leads to fulfillment of that goal, managers must choose a specific course of action and develop plans and controls to pursue that course. Because planning is future-oriented, uncertainty exists and information helps reduce that uncertainty. Controlling is making actual performance align with plans, and information is necessary for that process. Much of the information manager’s use to plan and control reflects relationships among product cost, selling prices, and sales volumes. Research in the field of CVP Analysis up-to-date, has been mainly preoccupied with the accounting systems of large manufacturing and merchandising companies, while studies of organizations in the service sector was directed specifically at non-profit organizations in the public sector, At this stage, there are few empirical data and analyses on the reliance of CVP analysis in manufacturing companies. In all business enterprises, the implementation of cost volume profit analysis is very important and can never be overemphasized and to achieve this goal, target, and objectives, it is beckoned on the decision of the managers. It is the contention that the researcher, therefore, seeks to investigate the reliance of cost volume profit analysis as an aid in effective management decision making in the manufacturing industry.

 

1.2. STATEMENT OF THE PROBLEM

The major problem encountered by manufacturing industries when cost-volume-profit analysis stands as a basis for decision making is managerial inefficiency and this includes ignorance of this concept i.e. inability of the management to employ it in their decision making and also not knowing the importance of cost-volume-profit analysis .i.e. most manufacturing industries are not relevant in their decision making process. Secondly, most manufacturing industries in Nigeria do not determine the extent to which cost-volume-profit analysis affect their various decisions. Thirdly, manufacturing industries are also faced with the problem of how to make use of the available scarce resources in order to achieve the objective of profit maximization. Fourthly, another major problem manufacturing industry in Nigeriaencountered is when the application of cost-volume-profit analysis techniques is meant to apply, they don’t apply it in their enhancement of managerial efficiency of manufacturing industries. Despite that, the information provided by the accountant in the company should be sufficient for decision making to determine the estimate to produce. The accountant/production manager must know the inflation rate with respect to the company’s capital investments as regards the profitability structure of the variable component that is being incurred. The problem now is whether the company knows what cost they are incurred in order for them to produce the estimated value which they are setting for themselves. It would be difficult to imagine any organization achieving and sustaining effectiveness without cost volume profit analysis. Finally, the economy is not the same today as it has been in the past decade. The exchange rate of naira to foreign currencies and the price fixed for manufacturing goods and services greatly affect the profits to be made on the part of the manufacturers. If prices are not well fixed compared with the sale needed and cost incurred, it will pose a problem hence. It is against this backdrop that this research tends to argue that cost volume profit analysis serves as an effective tool in the management decision making of manufacturing companies.

 

1.3.  OBJECTIVES OF THE STUDY

Profit planning and control are essential ingredients or successful management at all levels. In fact, the efficiency of management is ensured by the number of profits in a given accounting year. The major objective of this research work is to assess the extent of reliance on CVP analysis for effective management decision making in manufacturing companies.

Other specific objectives of the study include:

Evaluate the usefulness of cost volume profit analysis in planning, controlling and evaluating the objective of the organization. Assess the adoption of cost volume profit analysis in management financial decision making.  Evaluate the financial decisions for determining the profit of a particular product. Determine the barriers affecting the implementation of CVP analysis for management decision making. Ascertain the effect of CVP analysis on the financial performance of manufacturing industries. Evaluate the extent to which the use of the cost-volume-profit technique has helped in achieving the profit maximization. Analyze the basic assumptions of CVP analysis to know their effect on firms especially those of the manufacturing sector.

1.4.  FORMULATION OF HYPOTHESIS

The hypothesis is an assumption or a concession made for the sales of argument in order to draw out and test its logical consequence. In carrying out this research work these conceptual statements are made to serve as a guide on which the work will be anchored. It is often stated in the null form. It includes:

Hypothesis One:

The application of CVP analysis graphs and ratios do not enhance profitability, productivity and efficiency decisions in manufacturing firms.

Hypothesis Two:

The applications of CVP analysis are not necessary for the effective control and management of costs.

General statement of the Hypothesis can be deduced thus; “That there is no significant relationship between CVP analysis and management financial decision making in manufacturing company.

 

1.5. SIGNIFICANCE OF THE STUDY

Above all, for an organization to succeed, it needs accurate planning and decision making. Therefore this research work will be of paramount importance to all manufacturing company, their manager and production staff of the company, as it will assist the management of various manufacturing firms by providing them a  simple tool that can be used for making decision, it will also provide a clearer understanding on how to identify the most profitable mix, discover the effective decision tool that can be used in determining the profit of a particular product, Ascertain which of their products result in large profit margin, opportunity to knowing changes in cost, which occur as a result of shift in policy concerning products, produced. Academically, this research study will also educate students more on the application of cost volume profit analysis, as it will also serve as reference material to another researcher who may carry out similar work in the nearest future. i.e. both the researchers, student, analyst, lecturers will all benefit from this research study.

 

1.6. SCOPE OF THE STUDY

This research study shall tend to focus on understanding how cost, volume, and profit interact. It shall also seek to give a clearer understanding of how these relationships help in predicting future conditions (planning) as well as in explaining, evaluating, and acting on results (controlling). It shall also tend to presents the concepts of the margin of safety and the degree of operating leverage. Information provided by these models helps managers focus on the implications that volume changes would have on organizational profitability. This study shall hover around the reliance of CVP analysis for effective management financial decision making in Wapco Cement Plc, Sagamu Plc. The research work will be carried out in Ogun State metropolis due to the schedule of the researchers.

 

1.7. LIMITATIONS OF THE STUDY

For all research study, there must exist cases of setback, hindrances, difficulties encountered, limitations and which needs to be acknowledged in the study.

The limitations of the study are as given below:

1. Financial Constraint/Time: The study cannot be expanded to cover other industrial areas due to available funds and time. Cost volume profit analysis itself has a wider scope, which needs a greater amount of time for careful study. Considering other academic activities, the researcher had a very limited time to carry out this research.

b). Information Obtained: The researcher is limited to available information obtained from the management and staff of the case study, due to the distance of the case study company from my school. The distance between the researcher and the case company posed a serious hitch to the smooth carrying out of this project.

c). Literature: The researcher notices that the libraries around are too poor as far as accounting textbooks, journals and magazines are concerned. It was not easy to obtain secondary data from the library as a result of the few books available to treat this research topic. Also, most updated textbooks are not at my disposal either, due to the poor library services or my personal poor finance.

 

1.8.DEFINITION OF TERMS

In other not to confuse the reader of this project and remove any doubt as to the intended meaning of the word and terms used in the study.  The researcher has certain words and terms as follows:

BREAK-EVEN ANALYSIS: This is the term given to the study of the interrelationships between cost, volume, and profit at various levels of activity, which produces neither profit nor loss.
COSTS: These are operating expenses for the business.
REVENUE: is the income derived from selling goods and services.
ASSETS: These are possession or wealth of a person, group of persons, company, corporation or government and such possession or wealth or property do have a monetary value.
LIABILITIES: A liability is the amount of money or value which a person or persons, or an organization owe to outsiders or other persons.
COST ACCOUNTING: It is the establishment of budgets, standard costs and the actual cost of operations, processes, activities or products, and the analysis of variance, profitability, or the social use of funds.
COST VOLUME PROFIT ANALYSIS:  It is used to examine the behavior of total revenue, total cost, and operating income as changes occur in the output level, the selling price, the variable cost per unit or the fixed cost of a product. CONTRIBUTION MARGIN RATIO: These are ratios that are used to represent the amount of revenue minus the variable cost that contributes to covering the fixed cost.
COST VOLUME CHART (CVPC): A chart that helps in the enrichment of understanding of the inter-relationship of all factors affecting profit especially cost behavior patterns over ranges of volume.
FIXED COST (FC): The cost that fixed in a total amount over a period of production, but varies per unit of output with the level of production changes.
VARIABLE COST (VC): The cost that directly affects production by varying the level of production but constantly remains fixed per unit of output.
BREAK-EVEN POINT (BEP): The point of activity where total cost are equal and the firm neither making profit nor loss. MARGIN OF SAFETY (MOS): This is the excess of budgeted sales over the break-even sales –volume
GROSS PROFIT RATIO (GPR): This is the commonest measure of profitability. The gross profit margin measures the efficiency with which the firm produces each unit. Its products by discounting all operating expenses.
NET PROFIT RATIO (NPR): The net profit margin measures the percentage of sales remaining after expenses including taxes have been deducted.

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