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Cost-Volume-Profit Analysis

Cost-Volume-Profit (CVP) analysis helps managers understand the relationships that exist between the costs of inputs, the volume of sales and the level of profit.

Break-Even Analysis: An important element of CVP. The break-even point is the level of sales the firm must reach to break even (cover their costs so there are no operating losses). Past the break-even point, operating income increases by the contribution margin of each additional unit sold.

Contribution Margin (CM): The amount of money from each unit sold above the variable costs of each unit. CM is kept by the company to cover fixed costs, or to contribute to operating income past the break-even point.

Contribution Margin per Unit = Price per Unit – Variable Cost per Unit
Contribution Margin = Sales – Variable Expenses
                           or  = CM per Unit * # Units Sold

Profit (Operating Income) = Contribution Margin – Fixed Expenses

Break-Even Point in Units Sold = Fixed Expenses/CM per Unit

Break-Even Point in Total Sales Dollars = Fixed Expenses/CM Ratio

Where, CM Ratio = CM per Unit/Selling Price

                        or = [Selling Price – Variable Cost per Unit]/Selling Price

Cost Structure: Refers to the relative proportion of fixed and variable costs in an organization.

Operating Leverage: A measure of how sensitive operating income is to a given percentage change in sales.

Degree of Operating Leverage = CM/Operating Income

CVP Assumptions:

  1. Selling price is constant through relevant range
  2. Costs are linear through relevant range and can be divided into variable and fixed elements
  3. In multiproduct companies, sale mix is constant
  4. In manufacturing companies, inventories do not change (produced = sold) 

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