CVP analysis, focusing on target net income rather than operating income ________.
A) will increase the breakeven point B) will decrease the breakeven point C) will not change the breakeven point D) will help managers construct a better capital policy explain the answer
The correct answer and explanation is:
The correct answer is A) will increase the breakeven point.
Explanation:
Cost-Volume-Profit (CVP) analysis is a financial tool used by managers to understand how changes in costs, volume, and pricing affect a company’s profit. Typically, CVP analysis is used to calculate the breakeven point, which is the level of sales at which total revenues equal total costs, resulting in zero profit or loss.
When the focus of CVP analysis shifts from operating income to target net income, it incorporates the requirement of achieving a specific level of profit after accounting for taxes and other expenses. This shift has a direct impact on the calculation of the breakeven point.
Why this increases the breakeven point:
- Fixed Costs and Target Net Income: If managers are targeting net income rather than just covering operating costs, they will need to factor in additional fixed costs. These could include taxes, interest, and other non-operating expenses, which were not previously considered in a simple operating income calculation.
- Higher Sales Needed: To meet the target net income, the company must generate enough revenue not only to cover its fixed and variable costs but also to cover the taxes and other expenses. This means the company needs to sell more units or generate more revenue to achieve the target.
- Increased Breakeven Point: The additional target net income increases the overall amount of money that must be generated to break even. Therefore, the breakeven point, which is the point where total revenues cover all costs (including target profit), will be higher than when only operating income was the focus.
In summary, targeting a specific net income rather than just operating income requires the company to generate more revenue to meet the profit goal, resulting in a higher breakeven point.