First of all, what is Cost Volume Profit (CVP) Analysis? This may seem like a complex method, but I assure you that you’ll be happy to know how using CVP can help you become a better marketer. To simply put it, CVP analysis is a method of cost accounting that inputs the shifting levels of costs and volume towards profit from a business operation. This method is also commonly called the break-even point, which reflects the same method of determining changes in costs within both variable and fixed costs and the sales volume that impact a business’ profit.
By looking at your business’ sales volume and influential factors that affect your profit, you can succeed within the business industry and use these strategic methods in making short and long term economic decisions.
How does CVP work?
The Cost-Volume-Profit analysis is like any method. It has main components that make it form a great process and methodology in understanding the influential factors affecting sales volume and profit for your business.
These 5 basic components include:
- Volume or level of activity
- Unit selling price
- Variable cost per unit
- Total fixed cost
- Sales mix
It also includes important margins of measures such as CVP income statement and revised income statement, the margin of safety, target net income, and shifts in business environments. Basically by using this method, you get a business forecast insider on influential factors to your sales volume and management tools on how to increase safe, long-term income for your successful business. This method is primarily for management to assess where the business is in terms of performance of profit and to review the variable and fixed costs of the business.
The cost-volume-profit formula
Selling price – Variable cost – fixed cost = profit
Let’s break down this formula and define it a bit more.
- Variable cost is a cost that shifts depending on the level output.
- A fixed cost is any business cost that is constant with whatever amounts of goods produced.
- Profit is a financial gain, in the result of a difference between revenue and spendings as revenue increases the amount of spending.
Another formula that can be used to calculate sales volume to cover costs and break even is the CVP breakeven sales volume formula:
Break even sales volume = FC (fixed costs) / CM ( Contribution Margin)
In order to apply the CVP formula, one must start a contribution margin format of an income statement.
Contribution Margin Income Statement
A contribution margin (CM) income statement follows a statement of income revenues minus goods sold which displays the companies gross margin. This method separates both fixed and variable costs but follows a similar concept that a regular income statement does.
The formula for a gross margin is:
Net sales – Cost of goods sold = Gross margin
Here is an example of a CM income statement. Consider the 5 core components that make up a CVP when looking at this example.
Margin costs ultimately assess the direct costs which include labour, materials, and expenses in producing a product. It analyses these costs and can allow a company to understand how they’re effectively distributing their costs and ways in which they can greater their business margin.
The greater the business margin, the more money a company can put in for other important expenses such as marketing.
What does CVP Analysis do for my business?
Basically the CM cost we just talked about, is the determination point in understanding the break-even-point of sales. Through reading a company’s CVP analysis, successful, long-term decisions can be enforced as beneficial decisions are made on the impact of the results shown. This will ultimately alter the way you think about your business and the profitable decisions you make in the future. By looking at your sales margins and your business market, you’re able to make decisions on important investments easier, as well as determining the effects on sales and profitability much quicker.
Whether you’re making passive income through your business or wanting to be smarter with your money, it’s valuable for anyone to understand the method of CVP analysis. It will not only benefit your knowledge of your variable and fixed costs that affect your income, but it will make you more aware of the margin costs that affect your overall business revenue levels.
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