Cost-volume-profit (CVP) analysis allows managers to see how changes in costs and volume will affect the company’s operating expenses and net income (for-profit) or net assets (non-profit). This form of analysis compares different relationships, such as the cost of operating and producing goods and services, the volume of goods and services sold, and the profits generated from the sale of those goods and services (Gapenski, 2012). Cost-volume-profit (CVP) analysis helps managers make rational decisions such as what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to maintain. Its primary purpose is to estimate how profits are affected by the following five factors: selling prices, sales volume, unit variable costs, and total fixed costs. The CVP analysis is also extremely helpful in determining the contribution margin (CM), which is the per-unit revenue from the sale of goods and services minus the per-unit variable costs (VC) associated with producing the goods or delivering the services, with the product being the amount remaining to cover the fixed costs (FC) and ultimately flows into the profits. We, as industry leaders, need to understand those variables that impact profit maximization, and then make changes, as necessary, to improve our firm’s financial position. The CVP model is one example of managerial accounting approach intended to aid managers in making smart financial and operational decisions.
Sources:
Gapenski, L. C. (2012). Healthcare finance: An introduction to accounting and financial management. (5th ed.). Chicago, IL: Health Administration Press
Garrison, R., Noreen, E., & Brewer, P. (2014). Managerial accounting (15th ed.). Columbus, OH: McGraw-Hill Education.
Unit Learning Outcomes
ULO 5. Utilize cost volume profit (CVP) analysis to aid in management decision-making. (CLO 2, 3, 4, and 7)
Directions
Initial Posting
Greenleaf Book Group is a book publishing company in Austin, Texas, that attracts authors who are willing to pay publishing costs and forgo up-front advances in exchange for a larger royalty rate on each book sold. For example, assume a typical publisher prints 10,000 copies of a new book that it sells for $12.50 per unit. The publisher pays the author an advance of $20,000 to write the book and then incurs $60,000 of expenses to market, print, and edit the book. The publisher also pays the author a 20% royalty (or $2.50 per unit) on each book sold above 8,000 units. In this scenario, the publisher must sell 6,400 books to break even ($80,000 in fixed costs ÷ $12.50 per unit). If all 10,000 copies are sold, the author earns $25,000 ($20,000 advance + 2,000 copies × $2.50) and the publisher earns $40,000 ($125,000 − $60,000 − $20,000 − $5,000). Greenleaf alters the financial arrangement described above by requiring the author to assume the risk of poor sales. It pays the author a 70% royalty on all units sold (or $8.75 per unit), but the author forgoes the $20,000 advance and pays Greenleaf $60,000 to market, print, and edit the book. If the book flops, the author fails to recover her production costs. If all 10,000 units are sold, the author earns $27,500 ( $10,000 units × $8.75 − $60,000) and Greenleaf earns $37,500 ( = 10,000 units × ($12.50 − $8.75)). Source: Christopher Steiner, “Book It,” Forbes, September 7, 2009, p. 58
The Greenleaf Publishing Company currently pays the author a 20% royalty on all units sold, but the author forgoes advances and pays Greenleaf to market, print, and edit the book. This is a bit different from the traditional payment method of Greenleaf’s competitors. They tend to employ a more traditional approach to compensating their authors in that they provide an advance to write the book, and then incur the expenses to market, print, and edit the manuscript. The publisher also pays the author a royalty on each unit sold above a certain threshold. Management has noticed a decline in the number of authors seeking to publish with the Greenleaf. The CEO has formed a special taskforce to investigate the loss in volume and formulate a plan of action to positively change the trajectory of the company. You are a member of the committee. An analysis has been performed using cost, price, and quantity data for both the traditional and non-traditional approach used by Greenleaf. Using the results from the analyses and additional information you deem to be relevant to this scenario, prepare a recommendation on what actions you believe the company should consider taking to reverse the current trends and maximize the firm’s potential for long-term success. Your recommendation should contain sound arguments that are well supported, properly vetted, and logically presented. It is important that management carefully consider any potential ethical implications associated with their stated position. If there are any potential ethical concerns associated with your position, they should be identified and discussed in the final recommendation. In order to formulate your recommendation, you may want to carefully consider the problem, the three (3) CVP assumptions, collect relevant data and information, critically evaluate the alternatives, and document your recommendations using sound arguments that are well supported, properly vetted, and logically presented.
