Figure 1- Graph 1 and 2
Cost profit volume analysis is an economic tool that is used by management accountants to try and understand the relationships between the various variables that determine the profitability of a product, by utilizing the variables costs, and volumes to determine profits (Qureshi, 1998). It determines how much of a product needs to be sold so that an organization can break even on that particular product, or even how much of a product needs to be sold so as to attain a given profitability with a given fixed and variable costs.
One important similarity is that for both the graphs, the total revenue is increasing with increase in the volumes sold. This is due to the simple fact that total revenue is total products sold multiplied by the price and therefore it follows that the more the products sold, the more the revenue received.
TR= P*Q so if Q (Quantity/volumes) is increases then definitely the total Revenue also increases for both the graphs.
Total revenue in Graph A is starting from another point other than point zero, and also increases at a a constant rate as opposed to graph 2 where the revenue starts from point zero and increases at an increasing rate, at least for the given time horizon. This shows a difference in either the product or the production technology as depicted in the two graphs.
The total cost, just as the total revenue, is increasing at a constant rate in Graph 1 but increasing at a decreasing rate in Graph 2.This means that for Graph one, the total costs will increase at a fixed rate regardless of the increase in production while for graph 2, the more products being produced, the less the cost of production per unit and therefore the declining curve.
In graph number 1, there is a fixed cost as shown by the total cost curve not starting at zero, while for the graph number two, fixed cost is zero and therefore, the graph starts at zero depicting variable costs only (Anderson, 1997).
Profit- for both graphs, both profit curves depict an increasing trend, at least for sometime before the second graphs profit starts to decline, while the profit line for the first graph depicts an increased profit at an increasing rate,atleast for the given time horizon.
Graph number one, is apparently in the short run, where all parameters are apparently increasing. Management accounting for the cost profit volume analysis explains that in the short run, we could have all the variables increasing, but then in the long run (graph 2,) its common knowledge that some of the variables must depict a declining trend. It’s logically impossible for instance not to have profits declining at some point, as the various market factors come to play. Competition for instance, would mean that the profitability for the product would have to decline at some point as the costs of production get higher, or the selling prices come down due to competition and other market factors.
Total costs, too, cannot increase at a constant rate as its common accounting knowledge that the benefits of economies of scale must arise at some point and therefore the marginal costs must at some point show a declining trend as a result of the benefits of producing in a larger scale. This therefore, brings us to the conclusion that graph number two depicts a more reasonable trend as compared to graph number 1 (National Association of Accountants,2009)
Anderson, C. W. (1997). Disclosure of assumptions key to better break-even analysis. National Association of Accountants NAA Bulletin, 39(4), 25–30.
Barnett, R. A., & Ziegler, M. R. (1991). Essentials of college mathematics: For business, economics, life sciences and social sciences (2nd ed.). New York: Dellen.
Qureshi,AM (1998) Analysing Business Strategy: The Uses of Cost-volume-profit Analysis. Institute of Cost and Management Accountants
National Association of Accountants (2009), Management accounting. University of California