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, 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:

Breakeven Sales Volume=fc/cmwhere: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.

How Is Cost-Volume-Profit (CVP) Analysis Used?

Cost-volume-profit analysis is used to determine whether there is an
economic justification for a product to be manufactured. A target profit margin
is added to the breakeven sales volume, which is the number of units that
need to be sold in order to cover the costs required to make the product and
arrive at the target sales volume needed to generate the desired profit. The
decision maker could then compare the product's sales projections to the
target sales volume to see if it is worth manufacturing.

What Assumptions Does Cost-Volume-Profit (CVP)

Analysis Make?
The reliability of CVP lies in the assumptions it makes, including that the
sales price and the fixed and variable cost per unit are constant. The costs
are fixed within a specified production level. All units produced are assumed
to be sold, and all fixed costs must be stable. 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.

What Is Contribution Margin?

The contribution margin can be stated on a gross or per-unit basis. It
represents the incremental money generated for each product/unit sold after
deducting the variable portion of the firm's costs. Basically, it shows the
portion of sales that helps to cover the company's fixed costs. Any remaining
revenue left after covering fixed costs is the profit generated. So, for a
business to be profitable, the contribution margin must exceed total fixed
costs.

What Is the Breakeven Point (BEP)?

The breakeven point (breakeven price) for a trade or investment is
determined by comparing the market price of an asset to the original cost; the
breakeven point is reached when the two prices are equal.

In corporate accounting, the breakeven point (BEP) formula is determined by

dividing the total fixed costs associated with production by the revenue per
individual unit minus the variable costs per unit. In this case, fixed costs refer
to those that do not change depending upon the number of units sold. Put
differently, the breakeven point is the production level at which total revenues
for a product equal total expenses.

Understanding Breakeven Points (BEPs)

Breakeven points (BEPs) can be applied to a wide variety of contexts. For
instance, the breakeven point in a property would be how much money the
homeowner would need to generate from a sale to exactly offset the
net purchase price, inclusive of closing costs, taxes, fees, insurance, and
interest paid on the mortgage—as well as costs related to maintenance and
home improvements. At that price, the homeowner would exactly break even,
neither making nor losing any money.

Traders also apply BEPs to trades, figuring out what price a security must
reach to exactly cover all costs associated with a trade, including taxes,
commissions, management fees, and so on. A company’s breakeven point is
likewise calculated by taking fixed costs and dividing that figure by the gross
profit margin percentage.

Benefits of a Breakeven Analysis

A breakeven analysis can help with many things, including:
  Finding missing expenses. A breakeven analysis can help uncover
expenses that you otherwise might not have seen coming. Your
financial commitments will be determined at the end of a breakeven
analysis, so there won’t be any surprises down the line.
 Limiting decisions based on emotions. Making business decisions
based on emotions is rarely a good idea, but it can be hard to avoid. A
breakeven analysis leaves you with hard facts, which is a better
viewpoint from which to make business decisions.
 Setting goals. You will know exactly what kind of goals need to be met
to make a profit after a breakeven analysis. This helps you set goals
and work toward them.
 Securing funding. Often, you will need to use a breakeven analysis to
secure funding and show investors the plan for your business.
 Pricing appropriately. A breakeven analysis will show you how to
properly price your products from a business standpoint.

usiness Breakeven Points

The breakeven formula for a business provides a dollar figure that is needed
to break even. This can be converted into units by calculating the contribution
margin (unit sale price less variable costs). Dividing the fixed costs by the
contribution margin will provide how many units are needed to break even.

Business Breakeven=Fixed CostsGross Profit MarginBusiness 
Breakeven=Gross Profit MarginFixed Costs
The information required to calculate a business’s BEP can be found in
its financial statements. The first pieces of information required are the fixed
costs and the gross margin percentage.

Assume a company has $1 million in fixed costs and a gross margin of 37%.
Its breakeven point is $2.7 million ($1 million ÷ 0.37). In this breakeven point
example, the company must generate $2.7 million in revenue to cover its
fixed and variable costs. If it generates more sales, the company will have a
profit. If it generates fewer sales, there will be a loss.

It is also possible to calculate how many units need to be sold to cover the
fixed costs, which will result in the company breaking even. To do this,
calculate the contribution margin, which is the sale price of the product
less variable costs.
Assume a company has a $50 sale price for its product and variable costs of
$10. The contribution margin is $40 ($50 - $10). Divide the fixed costs by the
contribution margin to determine how many units the company has to sell: $1
million ÷ $40 = 25,000 units. If the company sells more units than this, it will
show a profit. If it sells fewer, there will be a loss.

What is a breakeven point?

A breakeven point is used in multiple areas of business and finance. In
accounting terms, it refers to the production level at which total production
revenue equals total production costs. In investing, the breakeven point is the
point at which the original cost equals the market price. Meanwhile, the
breakeven point in options trading occurs when the market price of an
underlying asset reaches the level at which a buyer will not incur a loss.

How do you calculate a breakeven point?

Generally, to calculate the breakeven point in business, fixed costs are
divided by the gross profit margin. This produces a dollar figure that a
company needs to break even.