Caribbean Internet café, CVP Analysis

Cost-Volume-Profit analysis

 

One of the most basic planning tools available to the managers is the ‘Cost-volume-profit’ analysis. ‘Cost-volume-profit’(CVP) analysis examines the behavior of total revenues, total costs, and operating income as changes occur in the output level, selling price, variable cost per unit, or fixed costs. CVP analysis is most commonly used by the managers as a help to answer them such questions as to the effect of sale of additional units on the revenue and the cost; the effect on the earnings of the company if the selling price is raised or reduced. By examining the various possibilities and alternatives, CVP analysis illustrates various decision outcomes and thus serves as an invaluable aid in the planning process (Horngren et al., 2002).

There are several assumptions in making a cost-volume-profit analysis. Some of the assumptions are:

• Changes in the total revenues and costs are caused only by changes in the number of product or service unit produced and sold.
• It is possible to segregate the total costs into fixed and variable components, where the variable component changes in line with changes in the level of output.
• The total revenues and total costs must have linearity in relation to output units within the relevant period, when the revenues and costs are plotted in a graph.
• The variables such as unit selling price, unit variable costs and fixed costs are explicit and they remain constant over a specific period.
• One of the important assumptions of CVP analysis is that the analysis assumes the sale of a single product or the sales mix (in the case of multiple products) remains unchanged even when the total sales level change.
• The other assumption is that it is possible to compare all revenues and costs without considering time value of money.

Most of these assumptions can very well fit into the cost structure of Caribbean Internet café, and hence the cost-volume-profit analysis can be adopted to decide on the expansion of the business of the firm.

The company is able to differentiate the variable costs by clearly establishing the relationship of some of the expenses to the usage of the cafe in terms of computer hours. For instance, the costs of food and drinks, representing costs that varies directly with the usage of the café by the customers.

This technique is used to determine the change in profit due to changes in volumes, costs and prices. Several approaches are applied even though all of them integrate at one point. One of the approaches is the graph method where the total costs and total revenues are plotted to form two different lines. For making the CVP analysis for Caribbean Internet café, this report will use a CVP graph instead of adopting a calculation method. As a first step, the total costs need to be segregated into fixed costs and the variable costs.

The employees are going to be 12 in number given that per the 90 hours that are going to be worked during the week, there are two people on duty. This implies that there are going to be a total of 180 hours that need to be covered. The charge per hour is 40 and the employees work in shifts of 15 hours per week. If the 180 hours are divided by the number of hours worked by each employee then multiplied by the hourly rate, the answer is then multiplied by the number of weeks in a month, which are four. Then to get the whole year’s amount it is multiplied by 12.

 

 

The following table shows the different costs are shown in the table below.

Cost Table

 

 

There is one shortcoming of the CVP analysis in that CVP is used mainly to make decisions in the short run only where the revenue expenditures are taken into consideration and the capital expenditures are left out of consideration.

Cost and Profitability under Different Business Scenarios

In order to consider the costs and profitability under different business scenarios, the costs are multiplied by the expected number of customers in good, average and bad business scenarios.

The assumption in this case is that only 40% of the visitors will use the internet, while all the visitors to the café are expected to spend money on food and drinks. The cost analysis and revenue analysis tables are appended below:

 

 

Cost Table

 

 

Revenue Table

Total market segment=20,000

 

 

The numbers of visits result in different revenue turnovers for the internet usage as well as towards food and drinks. This is because out of the total number of visits only 40% of the visitors are likely to use the internet. The business situations have varying amounts of visits and the market segment of 20,000 is multiplied by the respective percentages to obtain the visits for that particular scenario. Since the average customer is to spend 140 on drinks and 60 on food, the two figures are added together to arrive at the total revenue from the café.

 

Cost-Volume-Profit Table

 

The contribution margin is the difference between the total revenues and the variable cost and as an analysis criterion in CVP; the Contribution Margin ratio is used.  CM Ratio is the percentage of contribution margin on the revenues. The break-even point is the point where the total revenue and the total costs intersect and the graph exhibits this point clearly. The advantage of using the graph is that it encompasses both the CVP unit analysis and CVP revenue analysis.

CVP in terms of the unit analysis seeks to find out the least amount of units that the business needs to run and the formula is:

Q = F+ Profit

(P-V)

 

CVP that analysis the revenue seeks to use the contribution margin ratio that is the percentage by that the selling price exceeds the variable cost per unit. Simply stated this is the contribution margin as percentage of revenue. The formula is

CMR = P-V

P

 

 

This report considers the venture as profitable since profits are made even on average business situation.

References

Ivey, R. (1996). Caribbean Internet Café, The University of Western Ontario, London: Ivey Publishing

 

Horngren, C.T., Foster, G. & Datar, S.M., 2002. Cost Accounting: A Managerial Emphasis. New Delhi: Prentice Hall of India Private Limited.