What is Cost-Volume Profit Analysis
Cost-volume profit (CVP) analysis is a method of cost accounting that looks at the impact that varying levels of costs and volume have on operating profit. Cost-volume profit analysis looks to determine the break-even point for different sales volumes and cost structures, which 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 for price, cost and other variables, then plotting them out on an economic graph.
Cost-Volume Profit Analysis
BREAKING DOWN Cost-Volume Profit Analysis
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.
Cost-Volume Profit Analysis Formula
The basic CVP formula is the price per unit multiplied by the number of units sold, which 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.
Break-Even Point and CVP Analysis
The contribution margin is used in the determination of the break-even point of sales. By dividing the total fixed costs by the contribution margin ratio, the break-even 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 break even. 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.