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CVP Analysis

CVP analysis examines the interactions between price, volume, variable costs, fixed costs, and product mix to determine how changes in these factors affect a company's profitability. It allows companies to calculate key metrics like the break-even point, margin of safety, changes in net income, and degree of operating leverage. CVP analysis relies on assumptions that costs are fixed within a given production level and that all units produced will be sold. It provides a framework for companies to evaluate sales needs, understand cost behavior, and gauge the risks associated with changes in activity levels.

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27 views2 pages

CVP Analysis

CVP analysis examines the interactions between price, volume, variable costs, fixed costs, and product mix to determine how changes in these factors affect a company's profitability. It allows companies to calculate key metrics like the break-even point, margin of safety, changes in net income, and degree of operating leverage. CVP analysis relies on assumptions that costs are fixed within a given production level and that all units produced will be sold. It provides a framework for companies to evaluate sales needs, understand cost behavior, and gauge the risks associated with changes in activity levels.

Uploaded by

Hana Do
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CVP analysis is based on the interactions among the  The break-even point (BEP), in units, is the

following five elements: number of products the company must sell to


cover all production costs.
1. Price or revenue of products
2. Volume or level of activity BEP =Total Fixed Costs / CM per Unit
3. Per units variable costs
4. Total fixed costs.  Changes in Net Income (What-if Analysis)
5. Mix of products sold (CVP analysis requires an estimates how their net income will change
assumption about sales mix) with changes in sales behaviour.

 CVP is also commonly known as breakeven No. of units = (Fixed Costs + Target Profit) / CM
analysis. Ratio
 CVP analysis finds out how changes in
 Margin of Safety is commonly referred to as
variable and fixed costs affect a firm's profit.
the company’s “wiggle room” and shows by
 Companies can use CVP to see how many how much sales can drop and yet still break
units they need to sell to break even (cover all even.
costs) or reach a certain minimum profit
margin. Margin of Safety = Actual Sales – Break-even Sales
 CVP analysis is only reliable if costs are fixed
within a specified production level. All units  Degree of Operating Leverage tells
produced are assumed to be sold, and all fixed companies how net income changes in relation
costs must be stable in CVP analysis. to changes in sales numbers.

The main components of CVP analysis are:  The higher the number, the higher the
risk, because a higher DOL also means
that a 1% decrease in sales will cause a
1. CM ratio and variable expense ratio
magnified, larger decrease in net
2. Break-even point (in units or dollars)
income, ultimately decreasing its
3. Margin of safety
profitability
4. Changes in net income
5. Degree of operating leverage
DOL = CM / Net Income

 CM ratios and variable expense ratios are Several assumptions made:


numbers that companies generally want to see
to get an idea of how significant variable costs o Sales price per unit is constant.
o Variable costs per unit are constant.
are.
o Total fixed costs are constant.
o Everything produced is sold.
CM Ratio = Contribution Margin / Sales
o Costs are only affected because activity
changes.
Variable Expense Ratio = Total Variable Costs / Sales o If a company sells more than one product, they
are sold in the same mix.
 A high CM ratio and a low variable
expense ratio indicate low levels of  CVP analysis requires that all the company's
variable costs incurred. costs, including manufacturing, selling, and
administrative costs, be identified as variable
or fixed.
 Key calculations when using CVP analysis are
the contribution margin and the contribution
margin ratio.

 The contribution margin represents the


amount of income or profit the company made
before deducting its fixed costs.

At the Break-even Point:

 Profit or operating income equals 0.

 Total revenue equals total costs.

 Total contribution margin equals fixed


expenses

 The break-even point may be


calculated using either the
Equation Method or the
Contribution Margin Method

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