Finance

Apart from planning, monitoring daily operations and handling marketing programs, firms also allocate a significant amount of time on policy creation and decision making based on the results of their financial Planning. Specific Financial models or templates are being utilized to assess the current financial position of the firm. All these available models have become valuable tools for every company in any industry. A firm who does not apply any type of financial model, will have a hard time on either, knowing their precise cash or capital position, project business value or have problems on managing overall operational cash flow which can be a deterrent on plans for expansion or other activity that would provide business growth and sustainability.

The aim of this study is to critically evaluate specific financial models to be applied to firms on the motor industry. This study will also provide the financial models usefulness and assess its critical strengths and potential weaknesses. And finally this study will analyse how firms used financial models, to base their decisions and policy creation.

Objectives of the Organization Baseline for the Decision-Making Process
All organizations have their own objectives, each manager or owner before starting operations needs to identify first the basic goals of each firm. Once the ground work or objectives have been laid out and communicated to both the firms employees and shareholders, the daily operations will have only that focus and that is to satisfy those objectives. Planning and control activities are the main components of the decision-making process (Drury 20088), and that process follows sequential steps until a decision has been made.

A significant portion of time on this process usually will be spent on understanding the firms cash flow. Meaning making sure that there will be enough cash or working capital to continue operations, and also checking that expenses or business costs are all utilized and accounted for. Costs are very much important as revenues for managers of any enterprise, Costs is a component that is measured for inventory valuation, performance measurement, control, profit measurement and as discussed earlier decision-making process (Drury 200827). There are a lot of types of costs in business as well as methods and calculations on how to base decisions on necessary financial elements.

Costs and its relation to the Motor Industry
If one has to analyse costs in a particular industry, the motor or auto industry is good sector to start studying. This is an industry that can be considered as labour intensive usually requires a significant amount of capital (Investopedia ULC 2010). The common costs related to this industry are namely, labour, materials, advertising and also overhead or fixed costs. With possible heavy expenses especially costs on direct materials involve in this industry, managers look on various methods and utilize some financial models to understand their current position and make a decision based on its results.

One of the tools being used in the Motor industry is the Cost Volume Profit Analysis. This model uses all the necessary financial information of the organization and give emphasis to the interrelationships of quantity sold, costs and price (Hansen, Mowen and Guan 2007590). Accountants primarily apply this technique to plan future levels of activity in operation and also to offer important information about (AICPA 2003)

Which products or services to give emphasis to
To achieve a targeted level of profit, what would be the target Volume of Sales required
What would be the total amount of revenue needed to evade loss
How much to allocate for budget on discretionary expenditures
Whether to increase fixed costs
Whether fixed costs expose the organization to an unacceptable level of risk

Cost Volume Profit Analysis or (CVP) basically starts at the basic profit equation which is
Total revenue-Total costs  Profit. In a manufacturing industry such as the Motor business, there are two types of costs and that is the Variable costs, which are basically costs in direct relation to modifications in the operations level, they either increase or decrease depending on the activity (Tarantino 2002).Example of this is the cost of acquiring new materials for developing a new car model. Mostly, large manufacturer of automobiles have varied and usually large variable costs every time they introduce a new car on the market, variable costs can come also from the marketing campaign of these new models and labour on required to assemble them. The other type of costs is the fixed costs, which basically remains unchanged despite operational activity changes (same as Tarantino 2002). Thus profit formula now can be expressed as ProfitTotal revenue -Total variable costs- Total fixed costs. Thus in order to complete the equation for CVP the remaining components will be included
Unit Selling Price
Volume ( or also known as Level of Activity)
Variable Cost per Unit
Total Fixed Costs
Sales Mix

An added component when analyzing the CVP income statement is the inclusion of the Contribution Margin. The Contribution Margin is the amount left on total revenue after variable costs are deducted ( Harmon n.d.).

Cost Value Profit Analysis in Action Case Study
During the early 2000, One of the biggest companies in Motor manufacturing industry General Motors European division has incurred losses (Hansen, Mowen and Guan 2007590). The companys managers have used the CVP analysis to at least mitigate the problem by targeting the break-even point, which basically means that theres neither loss nor profit and sales level is at zero. To project break even the firm reduced 15 of their production capacity  and decrease their auto dealers from 870 to 470 (same as Hansen, Mowen and Guan 2007590).These actions has led to a significant reduction on Fixed costs and provide a realistic projection of breakeven in four years time. Managers have projected this with the help of CVP analysis, in which not only can help on understanding on what type of costs can be reduced but also to improve overall profitability.

To put to practice the CVP Analysis, we will provide some data on average unit price of automobiles, its variable costs, fixed costs and the multiplier which is basically the units to be sold.
Price10,000Variable Costs5,000Fixed Costs200,000Multiplier (Units Sold)1,000
Table 1 shows a computation of CVP with its graphical representation. The unit price per automobile is stated at 10,000, the multiplier or a unit sold is the assumption of total number of units to be sold on a given time, in this example a whole month. Variable costs is at 5,000, while fixed costs is constant on 200,000. The computation shows that for the first month given that the company have sold 1000 units of cars, multiplied by its selling price of 10,000 dollars. Total sales or revenue for that month is at 10 million dollars. To actualize the profit we will subtract the revenue from the fixed costs which is steady at 200,000 and the variable costs of 5 million dollars, since for every unit sold will be multiplied by the 5000 dollars of variable cost. Doing this, the company will have a profit of 4,800,000, and this applies also when instead of only 1000 units sold for that month, on the next row which the company projected 2000 units, will provide a profit of 9,800,000.

This analysis is very much useful for managers to know what exactly should be the price and volume needed to achieve desired profitability level.

Table 1. Source Authors computation.

Scenario Two
What if the variable costs have increased per unit of car And total unit sold will be only at 100 What will be the outcome
Price10,000Variable Costs8,000Fixed Costs200,000Multiplier (Units Sold)100

Looking at Table 2, we can clearly see the difference from the initial figures, with a projection of only 100 units sold and an increase of variable costs from 5,000 to 8,000, on the companys first month, they will reach the breakeven point with no loss or profit. Increasing the number of units sold however would provide a more precise expectation for profit as shown on the second row in which there were 200 cars sold. This would give Managers an idea that, they could have two options to gain profitability first they can reduce variable costs or better yet improve car sales to reach target number.
Table 2.SourceAuthors own computation.

Evaluation of  CVP
The CVP model, as displayed on the previous example, shows how easy it is to project breakeven point and level of profitability using the common financial elements for operations. Managers can quickly see what would be the outcome on a specific scenario based on its simple calculation, and can examine modification in profits in relation to changes sales volumes, costs, and prices. To determine which costs would be fixed or variable can sometimes be tricky, but once analyzed well, can provide reasonable accuracy.

But the model has its own limitations, first reviewing the graph on both tables in this study, we may notice that both costs and revenue are linear in response to its relevant range of operational activity, which means that CVP data can only be valid on its relevant range. Another limitation is that one of its assumptions such as variable unit costs and revenues are fairly constant which basically is fine for short term, although long run costs are a lot of times variable, Sales volume is the only main driver in this application as well. And lastly CVP cannot be used on multiple product mix, for example numerous cars models, since each one can have different variable costs and prices. On the auto industry it can only be applied on one model each time.

Conclusion
Managers use a lot of different approach in decision making, following an organized set of steps which correlates to the firms over all objectives. Tools such as financial models are used by these managers to further help them in making decisions and strategy planning. A Cost Volume Profit Model, is an example of that tool. It can provide a limited short term results based on basic financial components of costs, total revenue from units sold and profit. Although easy to use and has the ability to provide some valuable data, the CVP has its limitations such as its linearity, volume is the sole driver, and is not applicable to multi product mix. But despite those limitations, managers on the auto industry still uses this technique and to ensure more definitive and realistically feasible decisions, use other financial models available that would help almost any business scenario.