Accounting for Managers: Interpreting accounting information for decision-making

110 ACCOUNTING FOR MANAGERS

Using the same example, the margin of safety assuming anticipated sales of 25,000
units is:
25 , 000 − 20 , 000
25 , 000

× 100 =20%

The lower the margin of safety, the higher the risk, as sales do not have to fall
much before reaching the breakeven point. Conversely, there is less risk where
businesses operate with higher margins of safety.
Whereas the breakeven graph shows the breakeven point, theprofit–volume
graphshows the profit or loss at different levels of activity. For the same example,
the profit – volume graph is shown in Figure 8.2.
At any level of output the net profit (or loss) can be seen. This example shows the
breakeven point of 20,000 units and the small margin of safety to the anticipated
sales level of 25,000 units, compared with the risk of substantial loss following
from any level of activity below 20,000 units.
Despite the advantages presented by CVP analysis, there are some significant
limitations arising from the assumptions made:

žVolume is the only factor that causes prices and variable costs to alter (in practice,
production efficiencies, product/service mix, price levels etc. all influence costs
and revenues).
žThere is a single product/service or a product/service mix that remains con-
stant (in practice, product/service mix can vary significantly and different
product/services may have different cost structures, prices and contributions).
žCosts can be accurately divided into fixed and variable elements (although in
practice many costs are semi-variable and semi-fixed).
žFixed costs do not change (although in practice they vary with the range of
items produced and with product complexity, as we will see in Chapter 11).
žTotal costs and revenues are linear (while this is likely within the relevant
range, increases in volume may still lead to lower unit prices or economies of
scale and curvilinear costs and revenues may be more accurate).
žThe CVP analysis applies only to the relevant range (although decisions may
be made in the current period to move outside this range).
žThe analysis applies only to the short term and cannot reliably be used in the
longer term.

−250,000

−200,000

−150,000

−100,000

−50,000

0

50,000

100,000

150,000

0

5,00010,00015,00020,00025,00030,000

Net profit

Figure 8.2 Profit – volume graph for XYZ Ltd