|What is CVP Analysis?
- CVP (Cost-Volume-Profit) Analysis breaks down costs into
that are fixed and those that are variable and then uses this
for rational decision making.
1. How does a contribution margin-based income statement
2. What is contribution margin per unit (CMU)? What does it
- A contribution margin-based income statement organizes
and fixed to aid in management decision making. Knowing how costs
behave, management can better budget the profitability of various
This format also provides a better understanding of how volume changes
influences revenues, costs, and profit.
3. What is a contribution margin ratio? What does it tell
- The product’s CMU is the difference between its sales price
costs. This is an important concept for managers because it tells
them the amount of money each additional sale will contribute to
fixed costs and providing a profit. It equals the change in
resulting from one additional sale.
- CM ratio is the difference between selling price and
per unit (or revenues and total variable costs), expressed as a ratio
percentage of the selling price. Thus, a 40% contribution
ratio means 40 cents of every sales dollar is contributed to fixed
and profits. Or, each additional dollar of revenue creates
in extra profit
|CVP Assumptions and Limitations
- accurately break down costs into fixed and variable elements
- fixed costs will remain fixed during the period affected by
the decision being made
- variable costs vary in a linear fashion with sales
- works best when limited to a specific situation or
- economic and other conditions are assumed to remain
- it is only a guide to decision making
|The Profit Equation
==> the CVP Equation!
We use the profit equation to derive the CVP equations
- Profit = Revenues - Expenses
- now rewrite revenues as Sales price * volume
(i.e., number of units
- Profit = (SP * Vol) - Expenses
- now rewrite expenses as variable costs plus fixed
- Profit = (SP * Vol) - (VC +
- now rewrite VC as VC per unit * volume
- Profit = (SP * Vol) -
[(VC/unit * Vol) + FC]
- distribute the minus sign and collect terms
- Profit = Vol*(SP - VC/unit) - FC
- notice that SP - VC/unit is the same thing as
contribution margin per unit
- Profit = Vol*(CM/unit) - FC
- solving the equation for volume we get
FC + Profit
Vol(units) = -----------------
this is the CVP formula!
FC + Profit
Vol(units) = --------------
FC + Profit
Vol($) = --------------
When profit = 0
this is a break-even analysis
We can solve for either break-even volume or break-even revenues
1. Describe “what-if” analysis.
- “What-if” analysis changes a CVP equation variable and
seeks its effect
on volume, revenues, or profit. For example, a “what-if” scenario
might involve determining the extra profit from spending $10,000 on
if it increases sales by 10%.
2. What is the margin of safety? What does it tell
- The difference between the sales forecast and the
break-even point is
the margin of safety, which is usually expressed as a percentage of the
sales forecast. This is the percentage decline in sales that can occur
before the company reaches its break-even point.