How Costing Technique CVP analysis saved General Motors from Bankruptcy- A must Know case study for Cost Accountants and Costing students

 

CVP analysis is a very powerful tool and many companies have accepted its relevance. In the time of the recession this technique has saved many companies. The major example that we can take here is General Motors. In 2009 when recession in America was on its peak General Motors was facing survival issue. The company was in declining phase facing financial difficulties. The company's sales had plummeted, and it was losing billions of dollars each quarter. GM was on the verge of bankruptcy, and it needed to take drastic action to save itself.

And there comes a costing strategy named CVP analysis. In India generally we cost accountants know it as Break even Analysis or Variable cost Analysis. Off course this one was not the only single strategy adopted by GM, there were also some other strategies that were adopted at that time but CVP analysis played a crucial role.

And being a Cost Accountant, we must know what is CVP analysis and what was happened in 2009 in GM.

First let’s talk about CVP analysis. CVP stands for Cost-Volume-Profit analysis is a business tool that helps cost accountants to understand the relationship between costs, volume, and Profit. It is used to determine how many units of a product or service a company must sell to cover its costs and make a profit.

 Key components of CVP analysis:

1.       Selling price: The price at which a product or service is sold.

2.   Variable costs: The costs that vary with the amount of product or service produced, such as raw materials and direct labor.

3.     Fixed costs: The costs that do not vary with the amount of product or service produced, such as rent and salaries.

4.      Contribution margin: The difference between the selling price and the variable cost per unit.

5.      Break-even point: The sales volume at which the total revenue equals the total cost, resulting in zero profit.

6.      Target profit: The desired level of profit.

CVP analysis can be used to:

a)      a) Determine the break-even point.

b)   b)  Estimate the profit or loss at a given sales volume.

c)     c) Evaluate the impact of changes in selling price, variable costs, or fixed costs on profit.

d)     d)Make pricing decisions.

e)      e)Develop production plans.

 

Let’s take a small example thereafter we will go on GM.

A company sells a product for Rs. 20 per unit. The variable cost to produce each unit is Rs. 12, and the fixed costs are Rs. 10,000 per month. The company wants to make a profit of Rs. 2,000 per month.

First of all, we need to calculate contribution margin per unit. Here contribution margin per unit is 8 i.e. Sale – Variable cost. The second step is to calculate Break Even Point.

The break-even point can be calculated using the following formula:

 

Break-even point = Fixed costs / Contribution margin per unit

 

In this case, the break-even point is 10,000 / 8 = 1,250 units.

 

After knowing that we need to sale at least 1250 units to cover up total cost we need to focus on our target profit and for target profit which is Rs. 2000 in this case. For this we need to calculate sales volume needed for the targeted profit which can be calculated as

Sales volume = (Target profit + Fixed costs) / Contribution margin per unit

 

In this case, the sales volume needed to reach the target profit is (2,000 + 10,000) / 8 = 1,500 units.

For earning 2000 profit every month the company must have sale of 1500 units per month.

This one is a small example and in practical life there are numerous factors that affects CVP analysis. Things are not so easy as solving example of a book, but if your concept are clear then definitely you can overcome any hurdles.

Now comes to the GM case study.

As told earlier in 2009 GM was in difficult time. To overcome the recession company adopted several strategies and one of the key strategies was CVP analysis. GM implemented the CVP analysis to identify which car models were profitable and which were not. The company found that many of its large, gas-guzzling SUVs were losing money, while its smaller, more fuel-efficient cars were making a profit.

GM used this information to make a number of key decisions about its product lineup. The company discontinued several of its unprofitable SUV models, and it invested heavily in developing new fuel-efficient cars. These decisions helped GM to turn its business around and return to profitability in just a few years.

Here is a more detailed look at how GM used CVP analysis in 2009:

 

1. GM identified the variable and fixed costs for each of its car models.

Variable costs are the costs that vary with the amount of product or service produced, such as the cost of raw materials and direct labor. Fixed costs are the costs that do not vary with the amount of product or service produced, such as rent and salaries.

2. GM calculated the contribution margin for each car model. 

The contribution margin is the difference between the selling price of a product and the variable cost of producing it. The contribution margin represents the amount of money that each unit of a product contributes to covering fixed costs and generating profit.

3. GM used its contribution margin data to identify which car models were profitable and which were not.

A car model is profitable if its contribution margin is greater than its fixed cost per unit. A car model is unprofitable if its contribution margin is less than its fixed cost per unit.

4. GM made a number of key decisions about its product lineup based on its CVP analysis.

GM discontinued several of its unprofitable SUV models, such as the Hummer and the Pontiac GTO. The company also invested heavily in developing new fuel-efficient cars, such as the Chevrolet Volt and the Cruze.

5. GM's CVP analysis was a critical factor in its turnaround.

The company's decision to focus on fuel-efficient cars helped it to weather the recession and return to profitability in just a few years.

 

The following car models that were discontinued and continued by GM after CVP analysis.

Car Model	Status
Hummer H1	Discontinued
Hummer H2	Discontinued
Hummer H3	Discontinued
Pontiac GTO	Discontinued
Saturn Ion	Discontinued
Saturn Vue	Discontinued
Saab 9-7	Discontinued
Saab 9-5	Discontinued
Saab 9-3	Discontinued
Oldsmobile Alero	Discontinued
Oldsmobile Aurora	Discontinued
Oldsmobile Bravada	Discontinued
Oldsmobile Silhouette	Discontinued
Chevrolet Monte Carlo	Discontinued
Chevrolet Uplander	Discontinued
Pontiac Grand Prix	Discontinued
Pontiac Bonneville	Discontinued
Pontiac Sunfire	Discontinued
Buick LeSabre	Discontinued
Buick Park Avenue	Discontinued
Buick Rendezvous	Discontinued
Cadillac DTS	Discontinued
Cadillac STS	Discontinued
Chevrolet Camaro	Continued
Chevrolet Corvette	Continued
Chevrolet Cruze	Continued
Chevrolet Equinox	Continued
Chevrolet Impala	Continued
Chevrolet Malibu	Continued
Chevrolet Silverado	Continued
Chevrolet Sonic	Continued
GMC Canyon	Continued
GMC Sierra	Continued
GMC Terrain	Continued
GMC Yukon	Continued
Cadillac Escalade	Continued
Cadillac SRX	Continued
Buick Enclave	Continued
Buick LaCrosse	Continued
Buick Regal	Continued
Buick Verano	Continued

 

GM's CVP analysis in 2009 is a great example of how this powerful tool can be used to make informed business decisions. By identifying which car models were profitable and which were not, GM was able to make the necessary changes to its product lineup to save itself from bankruptcy.

 to be continued.....