What is 'Cost-Volume Profit Analysis'
Cost-volume profit (CVP) analysis is based upon determining the breakeven point of cost and volume of goods and can be useful for managers making short-term economic decisions. Cost-volume profit analysis makes several assumptions in order to be relevant including that the sales price, fixed costs and variable cost per unit are constant. Running this analysis involves using several equations using price, cost and other variables and plotting them out on an economic graph.
BREAKING DOWN 'Cost-Volume Profit Analysis'
CVP analysis is a method of cost accounting that is concerned with the impact varying levels of sales and product costs will have on operating profit. CVP analysis is only reliable if costs are fixed within a specified production level. All units produced are assumed to be sold and all costs must be variable or fixed in a CVP analysis. Another assumption is all changes in expenses occur because of changes in activity level. Semi-variable expenses must be split between expense classifications using the high-low method, scatter plot or statistical regression.
Basic CVP Formula
The basic CVP formula is the price per unit multiplied by the number of units sold equals the sum of total variable costs, total fixed costs and accounting profit. Total variable costs equal the number of units sold multiplied by the variable cost per unit.
Contribution Margin & Contribution Margin Ratio
CVP analysis also manages product contribution margin. Contribution margin is the difference between total sales and total variable costs. For a business to be profitable, the contribution margin must exceed total fixed costs. The contribution margin may also be calculated per unit. The unit contribution margin is simply the unit variable cost subtracted from the unit sales price. The contribution margin ratio is determined by dividing the contribution margin by total sales.
Breakeven Point of Sales
The contribution margin in used in the determination of the breakeven point of sales. By dividing the total fixed costs by the contribution margin ratio, the breakeven point of sales in terms of total dollars may be calculated. For example, a company with $100,000 of fixed costs and a contribution margin of 40% must earn revenue of $250,000 to breakeven. Profit may be added to the fixed costs to perform CVP analysis on a desired outcome. For example, if the previous company desired an accounting profit of $50,000, the total sales revenue is found by dividing $150,000 (the sum of fixed costs and desired profit) by the contribution margin of 40%. This example yields required sales revenue of $375,000.