The Cost Volume Profit Analysis of a company displays how the changes in cost and volume affect a company’s profit. A CVP analysis consists of five basic components that include: volume or level of activity, unit selling price, variable cost per unit, total fixed cost, and sales mix. A Cost-Volume-Profit Analysis also consists of the CVP income statement, break-even analysis, margin of safety, target net income, changes in business environment, and the CVP income statement revisited. These components are vital to determining the success of a company through profit margins.
The five basic components interrelate based on well thought out assumptions in a CVP analysis. The volume or level of activity displays the costs and revenues shows relevance in range in activity; activity levels are displayed as different measurement bases in a company. The variable cost per unit is determined by dividing the change in total cost by the high minus low activity level. Total fixed costs remain the same and do not change as activity may change. The sales mix is the fifth component of the basic components of a Cost Volume Profit Analysis. The sales mix shows a combination of products sold in a CVP. The five basic components help define profit in a CVP analysis. Without the CVP, profit could not be accurately determined.
Aside from the five basic components of a CVP analysis, there are many other important factors that display a company’s success. A CVP income statement evaluates costs and expenses in a period and also reports the contribution margin. In a CVP analysis there is a break even analysis that determines a point where total revenues equal total costs, also known as the break-even point. The break-even point can be found using a mathematical equation, finding the point on a CVP graph or simply by using the contribution margin technique. A margin of safety is also displayed, which is the amount of sales at a break-even point and the actual or expected sales for the company. Next, the income is projected for certain products, this is known as the target net income. The Cost-Volume-Profit Analysis then closes with reporting changes in the business environment and revisits the CVP income statement to review profit analysis and projections over a period of time.
Another important aspect of a Cost-Volume-Profit Analysis is the contribution margin. The contribution margin is the revenue remaining after deducting variable costs. If the unit selling price increases, the contribution margin per unit will decrease provided the unit variable costs remain the same and do not also rise. If the unit variable costs rise with the selling costs, the contribution margin might remain the same or may not show as much of an increase. For example, A 12 ct. box of pillows is one unit and sells for $60, and one pillow sells for $12 in retail. The unit selling price then increases to $70 the contribution margin is decreased because the profit of the unit decreases.
Fixed costs are another factor to consider in a Cost-Volume-Profit Analysis. Fixed cost by itself does not increase or decrease, but a fixed cost per unit may show a change in rates. If the fixed price per unit decreases then the Items produced will decrease, and the sales of the item will be lowered until there is no more of the product to sale. For example, a fixed cost in a company could be taxes, the taxes implemented on any product cannot change, but a fixed price per unit can. If the fixed cost per unit of candy canes sold during the Christmas season decreases, then the production of the candy canes will also show a decline. The decline in the production of candy canes will eventually thin out to nothing. A change in fixed costs can alter the sale of a product from any company.
Contribution margin ratios are sometimes more preferred in a CVP analysis. A contribution margin ratio is a percentage of sales contributing to a company’s net income. The contribution margin per unit divided by the unit selling price gives you the contribution margin ratio. If one of the components of the contribution margin ratio changes, the company’s net income will also change. If the sales increase, then the net income will increase. By the sales increasing, the unit selling price can be decreased and increase the contribution margin to the company. The contribution margin can improve the net income of the company but is very dependent on the sales of a company. There are many factors that determine the net income of a company, and the main factors are all displayed in a Cost-Volume-Profit Analysis income statement.