Cost-Volume-Profit Analysis (CVP)
Cost-Volume-Profit Analysis (CVP) is a financial analysis tool that helps businesses understand the relationship between costs, sales volume, and profit. It allows management to determine how changes in costs and volume affect a company’s operating income and Net Income. CVP analysis is crucial for decision-making regarding pricing, product mix, and production levels.
Key Components:
- Fixed Costs: Costs that do not change with the level of production or sales (e.g., rent, salaries).
- Variable Costs: Costs that vary directly with production volume (e.g., materials, labor).
- Sales Price: The amount charged to customers for each unit sold.
- Contribution Margin: Sales price per unit minus variable cost per unit, representing the amount available to cover fixed costs and contribute to profit.
Formula:
Profit = (Sales Price per Unit × Quantity Sold) – (Variable Cost per Unit × Quantity Sold) – Fixed Costs
Example:
Consider a company that produces and sells a product for $20. The variable cost per unit is $12, and the total fixed costs are $40,000. The contribution Margin per unit is $8 ($20 – $12). To break even:
Break-Even Point (Units) = Fixed Costs / Contribution Margin per Unit = $40,000 / $8 = 5,000 units.
Case Study:
A software company evaluates launching a new application. The fixed costs for development are estimated at $100,000, and the variable cost per user is $5. The application will be sold for $50 per subscription. Using CVP analysis, they determine:
Contribution Margin per Subscription = $50 – $5 = $45.
Break-Even Point = $100,000 / $45 ≈ 2,222 subscriptions. They aim to sell 3,000 subscriptions to ensure profitability.