Cost Volume Profit Analysis

Cost-Volume-Profit (CVP) analysis is a managerial accounting technique that is concerned with the effect of sales volume and product costs on operating profit of a business. It deals with how operating profit is affected by changes in variable costs, fixed costs, selling price per unit and the sales mix of two or more different products.

CVP analysis has following assumptions:

  1. All cost can be categorized as variable or fixed.
  2. Sales price per unit, variable cost per unit and total fixed cost are constant.
  3. All units produced are sold.

Where the problem involves mixed costs, they must be split into their fixed and variable component by High-Low Method, Scatter Plot Method or Regression Method.

CVP Analysis Formula

The basic formula used in CVP Analysis is derived from profit equation:

px = vx + FC + Profit

In the above formula,
   p is price per unit;
   v is variable cost per unit;
   x are total number of units produced and sold; and
   FC is total fixed cost

Besides the above formula, CVP analysis also makes use of following concepts:

Contribution Margin (CM)

Contribution Margin (CM) is equal to the difference between total sales (S) and total variable cost or, in other words, it is the amount by which sales exceed total variable costs (VC). In order to make profit the contribution margin of a business must exceed its total fixed costs. In short:

CM = S − VC

Unit Contribution Margin (Unit CM)

Contribution Margin can also be calculated per unit which is called Unit Contribution Margin. It is the excess of sales price per unit (p) over variable cost per unit (v). Thus:

Unit CM = p − v

Contribution Margin Ratio (CM Ratio)

Contribution Margin Ratio is calculated by dividing contribution margin by total sales or unit CM by price per unit.

Written by Irfanullah Jan