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What is CVP Analysis?
Cost Volume Profitability Analysis (CVP Analysis) is the study of the relationship between revenues, costs and profits of a business. The analysis is used to examine the relationship among the total volume of an independent variable, total costs, total revenues and profits for a time period. Cost-volume-profit analysis is useful in the early stages of planning because it provides an easily understandable framework for discussing planning issues and organizing relevant data.
CVP analysis begins with the basic profit equation
Where, Profit = Total Revenue – Total Costs
Separating costs into variable costs and fixed costs, we express profit as:
Profit = Total Revenue – Total Variable Costs – Total Fixed Costs
Profit + Fixed Costs = Sales – Variable Costs or Units Sold ×(Unit Sales Price – Unit Variable Cost)
Contribution margin = Sales –Variable Costs Unit
Contribution margin = Unit Sales Price – Unit Variable Cost
Quantity = Fixed Cost ÷ Unit Contribution margin
If we assume the selling price and the variable cost per unit to be constant, then the total revenue is equal to price multiplied by quantity and total variable cost is equal to the variable cost per unit multiplied by quantity.
Profit = SP × Q – V × Q – F = (P – V) × Q – F
Where, SP = Selling Price
V = Variable cost per unit
P – V = Contribution margin per unit
Q = Quantity of products sold
F = Total Fixed Cost
Profit equation: Profit = (P – V) × Q – F
For quantity Q =(F+Profit)/((P-V) )
If a company wants to produce an electronic appliance with the following information
Price per unit = $500
Variable cost per unit = $300
Fixed cost related to the production = $1,000,000
Target Profit = $200,000
Estimated Sales = 9,000 units.
We can determine the minimum quantity the company has to sell in order to earn the profit will be equal to
Quantity = ($1000,000 + $200,000) ÷ ($500–$300) = 6000 units.
Managers often want to know the level of activity required to break even. A CVP analysis can be used to determine the break even point or level of operating activity at which revenues cover all fixed and variable costs, resulting in zero profit. Knowing about this point is very crucial for the business break-even point is the point that a new company wants to reach as quickly as possible in order to cover all the costs and start making real profits.
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