Select 1 of the 2 techniques/concepts discussed in your Discussion Board Forum 2 thread and develop a real-world application paper. Select a company that you work for now or have worked for in the past, or a company in your community of which you have sufficient knowledge. Show how the selected technique/concept would be applied to that particular business in its strategic allocation of financial resources in the area of capital budgeting decisions. Your paper must be in current APA format and must include references from at least 7 peer-reviewed journal articles. The paper must be at least 5–7 pages, not including the title page and reference page.
Expert Answer and Explanation
Short Term Profit Planning: Cost Volume profit Analysis real world application
Business practices and capital budgeting decisions
In regards to the real world business operations, every organization in the manufacturing sector operates according to the main principles of profit maximization (Yu, Ramanathan and Nath, 2014). While undertaking their daily activities, business managers come across series of challenges relative to planning, decision making and control. In order to respond to these challenges, an additional analysis needs to be carried out; accordingly, it crucial for the management to plan accordingly on the approaches to effective resource mobilization to cover their costs is a way that will lead to profit maximization.
As the management is committed to finding adequate data on the implication of certain actions on the profitability of the business, Cost Volume and Profit (CVP) analysis serves as a significant instrument in expediting organizational processes and streamlining the budgeting process (Blocher, Stout and Cokins, 2010). This approach helps the management make appropriate decisions concerning the control and planning in a way that adds value to the organization (Navaneetha, Punitha, Rashmi and Aishwariyaa, 2017). To further explore the significant elements of CVP on decision making, planning and resource management, this study will use the case of FoodVille restaurant and bakery, a middle level restaurant in California that serves, pastry, hot and cold gourmet food. However, before looking at the CVP as it is concerned the manager and decision making of FoodVille, it is important to explore the highlights of the tools with regards to fixed and variable costs. It follows that before a company can apply CVP, they should be able to separate their foxed from variable costs.
Cost Volume Profit Analysis
Notably, revenue forecasting is a highlight in determining the level of returns necessary for achieving the anticipated profits. In a business intends to establish the sales volume that they need to attain a definite level of output or profit, they are likely to use CVP analysis. This approach is primarily applied in the analysis of the way different set of operative and marketing decisions affect the profits in the business (Abdullahi, Sulaimon, Mukhtar and Musa, 2017).
In its application, this strategic planning and resource allocation tool have significant implications on the changes in volume, pricing, sales mix, profits, fixed and variable expenses. Accordingly, the CVP analysis is often referred to as the breakeven analysis and is depicted as a simple model that presumes that the sales volume is the principle driver of the underlying costs. The CVP analysis is often used in finding the desired profits in revenue and planning (Lulaj and Iseni, 2018). Further, in cost planning and budgetary decisions, the management presumes that quantity of sales and the anticipated level of profits are already set (the data is available through revenue planning). The organization will then work towards establishing the value of the needed costs (both fixed and variable) to achieve the anticipated profits and volume of sale.
Cost Volume Profit Analysis Real World Application
The pricing in food and pastry production relies on a series of internal and external components such as market demands, competitive market conditions and other highlights such as management of marketing policies (Alnasser, Shaban and Al-Zubi, 2014). Pointedly, the cost of products are influenced by a series of factors including product mix, volume, size of the business, price of the inputs and the production efficiency. The alternatives that involve the variation in the level of business activity do not often vary in direct proportion to the changes in volume (Lima, Trentin, Oliveira, Batistus and Setti, 2015); this is often an implication of cost behavior patterns.
CVP is applied by the management at FoodVille in planning and decision making processes designed to optimize the profits of the company. The basis presumption of the approach is that the variable costs and the fixed costs per unit remains to be constant, and the pricing per unit barely changes with volume (Ihemeje, Okereafor and Ogungbangb, 2015). However, in real world situation, all of these variables keep changing. Hence, the significance of the CVP in decision making.
Profit Volume chart
The implication of cost allocation and revenue at different levels of FoodVille operations can be represented through profit volume chart that note the loss areas at different levels of activities below the breakeven volumes and the profit area at the level of activities above the breakeven volume.
Figure 1: FoodVille Cost Volume-profit Chart
FoodVille uses CVP analysis in determining the implications of the variations in their product pricing, sales and volume on their short run profit. A carefully crafted CVP analysis demands an understanding of costs and their variable and fixed behavior with change in volumes (Lulaj et al., 2018). The illustration below shows the cost volume profit chart for a special pastry. Each cake sold for USD 20. The variable costs per cake is USD 12, and the monthly fixed costs are USD 40,000. The total cost line denoted the fixed costs of USD 40,000 in addition to USD 12 per item. Hence, the restaurant produces and sells 6,000 cakes, the total cost by the company is USD 112,000, made of USD 72,000 variable (USD 72,000= USD for every cake X 6,000 cakes backed and sold) and USD 40,000 fixed costs.
The total revenue line depicts the way the revenue increases with an increase in volume. The total revenue is USD 120,000 for sales of up to 6,000 units and a profit of USD 8,000. Through this, the company can establish its net income either through the construction of an income statement of by the use of profit equation. The contribution margin notes the cash that remains once the restaurant pays its variable costs. Accordingly, the remaining amount adds to cover the fixed cost and net income.
As far as budgeting, production and resource allocation is concerned, the CVP analysis of FoodVille Restaurant and bakery shows the cost data for pastry production in the underlying series of outputs from 1000 to 10, 000 cakes. Reaffirming the appropriate range is the range of food produced or the amount of sales that the principal cost behaviors presumptions are held to be true. For volumes outside this range, costs show different behaviors hence affecting the presumed interrelatedness. For example, when the restaurant backed and sold more than 100, 000 cakes in the month of June 2018, it could have been possible to increase production (hence incurring additional costs) or to engage the employees through additional work (hence incurring extra expenses and implications). In both cases, the presumed relationship of costs are no longer valid.
Strategic Planning: Capital Budgeting Decisions
In the underlying case, the company will apply the CVP analysis particularly when they have varying variable and fixed costs. Pointedly, in the underlying study, the kitchen wanted to acquire a new oven that would be used in the production of pastry. While the new equipment reduced the variable costs incurred by the restaurant, it increased their fixed costs. In the study, the CVP analysis would be applied in establishing the amount of the variable costs needed to decrease or maintain their current profit margin.
According to the statement by their chief executive officer in the 2018`s annual staff meeting, the restaurant recognized that the market is constantly changing and while the level of competition has increased, the consumer preferences are also changing. In this regard, the company is challenging itself to adopt to the changing industry and market trends. Through this, they will often apply CVP analysis if they are seeking to purchase alternative machinery. Pointedly, a particular machine is likely to have high initial costs but lesser operating costs. An alternative equipment might have low initial investment but incur the company a relatively high operating costs. For example, the outside catering unit intended to acquire a track. While it costed the company a significant amount of initial capital to a buy the truck, this decision saved them form incurring additional operating costs which were often spend on outsourcing transport services.
The company often weighs these options through the sales quantity; the sales quantity is then used to make appropriate decisions on the machine to purchase. On the occasions that they needed to increase their production, the company resorted to acquire equipment with lower operating cost as they will use it more often. Another highlight in cost planning is the changes made in salaries and remuneration of their employees. When the company needed to reduce the rate of commission and increase the salaries of their employees, they are likely to apply the CVP analysis in figuring out how much they needed to reduce the rate of commission in order to maintain the profits and increase their employee salaries.
Consequently, business in different sectors have noted CVP as a crucial tool both in strategic and long term planning decisions. Pointedly, the study by (Abdullahi et al., 2017) highlighted that CVP is one of the mostly applied methods of capital budgeting decisions; however, a series of challenges have been encountered particularly concerning the breakeven analysis. For example, it is assumed that the total and the unit variable costs do not change. The argument by (Lima et al., 2015) noted that the management need to adopt a culture that is framed along cost structures and management. In this regard, businesses should pay attention and carefully plan before making decisions that concern costs.
While the approach is used to establish the minimum volume of sale that can be made to avoid losses and the sales volume required to attain the expected profit levels, the tool is a significant component as far as budgeting, resource allocation and operations are concerned. The significance of CVP analysis is that it helps highlight the primary elements affecting the profits and helping the business to comprehend the effects of variations in the volume of sales and costs. The understanding of profit volume interrelatedness and cost behavior patterns provide intuitions that are crucial when making plans and decision making in both the long run and short run operations. With the different product lines of FoodVille, the CVP is extended to linear programing problems of short-term capacity utility in which different products are involved and conveniently incorporated into linear programming models.
Abdullahi, S. R., Sulaimon, B. A., Mukhtar, I. S., & Musa, M. H. (2017). Cost-Volume-Profit
Analysis as a Management Tool for Decision Making In Small Business Enterprise within Bayero University, Kano. Journal of Business and Management, 19(2), 40-45.
Alnasser, N., Shaban, O. S., & Al-Zubi, Z. (2014). The Effect of Using Break-Even-Point in
Planning, Controlling, and Decision Making in the Industrial Jordanian Companies. International Journal of Academic Research in Business and Social Sciences, 4(5), 626.
Blocher, E. J., Stout, D. E., & Cokins, G. (2010). Cost management: A strategic emphasis.
Ihemeje, J. C., Okereafor, G., & Ogungbangb, B. M. (2015). Cost-volume-profit analysis and
decision making in the manufacturing industries of Nigeria. Journal of International Business Research and Marketing, 1(1), 7-15.
Lulaj, E., & Iseni, E. (2018). Role of Analysis CVP (Cost-Volume-Profit) as Important Indicator
for Planning and Making Decisions in the Business Environment. European Journal of Economics and Business Studies, 4(2), 99-114.
Lima, J. D. D., Trentin, M. G. A., Oliveira, G. A., Batistus, D. R., & Setti, D. (2015). A
systematic approach for the analysis of the economic viability of investment projects. International Journal of Engineering Management and Economics, 5(1-2), 19-34.
Navaneetha, B., Punitha, K., Rashmi, M. J., & Aishwariyaa, T. S. (2017). An analysis of cost
volume profit of Nestlé limited. International Journal of Commerce and Management Research, 3, 66-68.
Yu, W., Ramanathan, R., & Nath, P. (2014). The impacts of marketing and operations
capabilities on financial performance in the UK retail sector: A resource-based perspective. Industrial Marketing Management, 43(1), 25-31.
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