A careful and accurate cost-volume-profit CVP analysis requires knowledge of costs and their fixed or variable behavior as volume changes.
A cost-volume-profit chart is a graph that shows the relationships among sales, costs, volume, and profit. Look at illustration below. The illustration shows a cost-volume-profit chart for Video Productions, a company that produces DVDs.
The total revenue line shows how revenue increases as volume increases. In the chart, we demonstrate the effect of volume on revenue, costs, and net income, for a particular price, variable cost per unit, and fixed cost per period. In other words, the point where sales revenue equals total variable costs plus total fixed costs, and contribution margin equals fixed costs. Similarly, the fixed costs represent total manufacturing, selling, and administrative fixed costs.
In this equation, the variable costs are stated as a percent of sales. This also works in reverse. CVP analysis is also used when a company is trying to determine what level of sales is necessary to reach a specific level of income, also called targeted income. To calculate the required sales level, the targeted income is added to fixed costs, and the total is divided by the contribution margin ratio to determine required sales dollars, or the total is divided by contribution margin per unit to determine the required sales level in units.
Remember that there are additional variable costs incurred every time an additional unit is sold, and these costs reduce the extra revenues when calculating income.
It is found in single product situations by either simply dividing the total contribution by the total sales revenue, or by dividing the unit contribution margin otherwise known as contribution per unit by the selling price:. The following information is available for both products:. The break-even point in sales revenue can now be calculated this way for Company A:. Of course, such calculations provide only estimated information because they assume that products X and Y are sold in a constant mix of 2X to 1Y.
In reality, this constant mix is unlikely to exist and, at times, more Y may be sold than X. Such changes in the mix throughout a period, even if the overall mix for the period is , will lead to the actual break-even point being different than anticipated.
This point is touched upon again later in this article. When discussing graphical methods for establishing the break-even point, we considered break-even charts and contribution graphs.
These could also be drawn for a company selling multiple products, such as Company A in our example. It is the cumulative figures which are needed to draw the graph.
It can be observed from the graph that, when the company sells its most profitable product first X it breaks even earlier than when it sells products in a constant mix. The break-even point is the point where each line cuts the x axis. Cost-volume-profit analysis. Cost-volume-profit analysis looks primarily at the effects of differing levels of activity on the financial results of a business In any business, or, indeed, in life in general, hindsight is a beautiful thing.
The objective of CVP analysis CVP analysis looks primarily at the effects of differing levels of activity on the financial results of a business. Ascertaining the sales volume required to achieve a target profit As well as ascertaining the break-even point, there are other routine calculations that it is just as important to understand. This is not a quick enough method to use in an exam so it is not recommended. Multi-product profit—volume charts When discussing graphical methods for establishing the break-even point, we considered break-even charts and contribution graphs.
Limitations of cost-volume profit analysis Cost-volume-profit analysis is invaluable in demonstrating the effect on an organisation that changes in volume in particular , costs and selling prices, have on profit. However, its use is limited because it is based on the following assumptions: Either a single product is being sold or, if there are multiple products, these are sold in a constant mix.
We have considered this above in Figure 3 and seen that if the constant mix assumption changes, so does the break-even point. Are you paying more in taxes than you need to? Every dollar makes a difference, and you can save more of them by taking ALL the tax deductions available to your business. In this page report, we've outlined the top 25 business tax deductions you could be taking and 5 to watch out for!
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