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.

Understanding Cost-Volume-Profit (CVP) Analysis

The cost-volume-profit analysis, also commonly known as breakeven analysis, looks to determine the breakeven point for different sales volumes and cost structures plotted on a profit-volume chart, which can be useful for managers making short-term business decisions. CVP analysis makes several assumptions, including that the sales price, fixed and variable costs per unit are constant. Running a CVP analysis involves using several equations for price, cost, and other variables, which it then plots out on an economic graph.

The CVP formula can also calculate the breakeven point. The breakeven point is the number of units that need to be sold or the amount of sales revenue that has to be generated in order to cover the costs required to make the product. The CVP breakeven sales volume formula is:

$\begin{aligned} &\text{Breakeven Sales Volume}=\frac{FC}{CM} \\ &\textbf{where:}\\ &FC=\text{Fixed costs}\\ &CM=\text{Contribution margin} = \text{Sales} - \text{Variable Costs}\\ \end{aligned}$​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. CVP analysis also manages product contribution margin. The 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.

The contribution margin is used to determine 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 break even.

Profit may be added to the fixed costs to perform CVP analysis on the desired outcome. For example, if the previous company desired a profit of $50,000, the necessary 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.

Special Considerations

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 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.