Corporate Finance & Accounting
Corporate Finance & Accounting Accounting
Cost-Volume-Profit – CVP Analysis Definition
By Will Kenton
What Is Cost-Volume-Profit – CVP 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. The cost-volume-profit analysis, also commonly known as break-even 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.
The cost-volume-profit analysis makes several assumptions, 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
Cost-Volume-Profit Analysis Formula Is
The CVP formula can be used to calculate the sales volume needed to cover costs and break even, in the CVP breakeven sales volume formula, as follows:
Breakeven Sales Volume=FCCMwhere:FC=Fixed costsCM=Contribution margin=Sales−Variable Costs\begin{aligned} &\text{Breakeven Sales Volume}=\frac{FC}{CM} \\ &\textbf{where:}\\ &FC=\text{Fixed costs}\\ &CM=\text{Contribution margin} = \text{Sales} - \text{Variable Costs}\\ \end{aligned}​Breakeven Sales Volume=CMFC​where:FC=Fixed costsCM=Contribution margin=Sales−Variable Costs​
To use the above formula to find a company's target sales volume, simply add a target profit amount per unit to the fixed-cost component of the formula. This allows you to solve for the target volume based on the assumptions used in the model.
What Does Cost-Volume-Profit Analysis Tell You?
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 a required sales revenue of $375,000.
CVP analysis is only reliable if costs are fixed within a specified production level. All units produced are assumed to be sold, and all fixed costs must be stable 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-price analysis is a way to find out how changes in variable and fixed costs affect a firm's profit.
Companies can use the formula result to see how many units they need to sell to break even (cover all costs) or reach a certain minimum profit margin.
Contribution Margin and 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 remainder after the unit variable cost is subtracted from the unit sales price. The contribution margin ratio is determined by dividing the contribution margin by total sales.
Break-Even Analysis
Break-even analysis calculates a margin of safety where an asset price, or a firm's revenues, can fall and still stay above the break-even point.
Cost Accounting Definition
Cost accounting is a form of managerial accounting that aims to capture a company's total cost of production by assessing its variable and fixed costs.
Breakeven Point (BEP)
In accounting, the breakeven point is the production level at which total revenues equal total expenses. Businesses also have a breakeven point, when they aren't making or losing money.
Managerial Accounting Definition
Managerial accounting is the practice of analyzing and communicating financial data to managers, who use the information to make business decisions.
How Operating Leverage Works
Operating leverage shows how a company's costs and profit relate to each other and changes can affect profits without impacting sales, contribution margin, or selling price.
Understanding Variable Cost
A variable cost is a corporate expense that changes in proportion to production output. Variable costs increase or decrease depending on a company's production volume; they rise as production increases and fall as production decreases.
Understanding Contribution Margins
How Operating Leverage Can Impact a Business
How can I calculate break-even analysis in Excel?
Regression Basics for Business Analysis
Reverse Engineering Return On Equity