CVP Analysis is a way to quickly answer a number of important questions about the profitability of a company's products or services. CVP Analysis can be used with either a product or service. Our examples will usually involve businesses that produce products, since they are often more complex situations. Service businesses (health care, accounting, barbers & beauty shops, auto repair, etc.) can also use CVP Analysis. It involves three elements:
Cost - the cost of making the product or providing a service Volume - the number of units of products produced or hours/units of service delivered Profit - Selling Price of product/service - Cost to make product/provide service = Operating Profit The first two items are information available to business managers, about their own business, products and services. This type of information is not generally available to those outside the business. They constitute important operating information that can help managers asses past performance, plan for the future, and monitor current progress. As for the third item, a business can't stay in business very long without profits. It is important to know whether the company is profitable as a whole. It is also important to know if a particular product is profitable. A business that sells 100 or more different products may lose sight of a single product. If that product becomes unprofitable (selling for less than the cost to produce & sell), the company will lose money on each and every sale of that product. The company might raise the selling price, cut production costs or discontinue the product entirely. Building a business with 100 products we know are profitable is good management. CVP & variable costing provide the tools to make this happen in a real business. A successful business can be built around a single profitable product. It can also be built around hundreds or thousands of profitable products. Many businesses start small and grow over time, adding products as they gain experience and are able to identify and/or develop new markets and products. No matter the size of the business or the number of products, the same rules apply. Each product must "carry its own weight" for the business to be profitable. Using CVP Analysis we can analyze a single product, a group of products, or evaluate the entire business as a whole. The ability to work across the entire product line in this way gives us a powerful tool to analyze financial information. It provides us with day-to-day techniques that are easy to understand and easy to use. The concepts parallel the real world, so they are easy to visualize and use. The math is very simple - no complex formulae or techniques. Just simple formulae that can be easily modified to analyze a large variety of situations.
Cost - product cost, consisting of materials, labor, overhead, etc. Volume - number of units of product sold in a given period of time Profit - Selling Price minus Cost, per unit or in total
The greater the volume, the greater the TOTAL profit.
Approaches to product costs
Full Costing is used in financial accounting. The full cost of a product includes materials, labor and manufacturing overhead. Not included: Selling and administrative costs. Variable Costing is used in managerial accounting. Costs are classified as either Variable or Fixed, depending on their Cost Behavior.
Costs are classified according to how they behave, in relation to units of production. CAUTION: Cost behavior can be viewed in terms of total costs or unit costs. Both approaches will be used, but they are not interchangeable.
Total Fixed Costs - stay essentially the same month to month, regardless of the number of units produced. Unit Fixed Costs - goes down as production goes up
Total Variable Costs - go up and down in direct proportion to units produced. Unit...