Learning Materials For Accounting, Management , Finance And Economics.

Sunday, October 2, 2011

Concept Of CVP Analysis Under Changing Situations Or Sensitivity Analysis

Sensitivity analysis is the measurement of responsiveness in outcome with the change in determinant variables. We know that the goal of a business enterprise is to maximize profits.
Profits are the excess of revenues over the total costs.
Net Profits = Total Sales Revenue- Total Costs
= Sales Units X Selling price per unit) -(Sales Units-Unit variable costs -Fixed Costs -Taxes)
So, Profit= f(Sales volume, Selling price, Variable costs, Fixed costs, Taxes etc.)

It means that profits are the functions of volume, price, variable costs, fixed costs, taxes and so on. But none of the factors remain unchanged. Sometimes the manager can intentionally change the price and cost factors as a part of strategic decisions. But the strategy should focus more on the factors which is more sensitive or responsive of profits. Therefore, to measure the sensitivity of CVP factors we can see the impact of certain percentage of change in volume, price or cost factors on net profits.

Therefore, sensitivity analysis is the measurement of elasticity of change in cost-volume-profit factors on the break even point or the given profits. A strategists or managers should focus on the factors which is more responsive to profits.