Cost-volume-profit (CVP) analysis focuses on the relationships of prices, costs, volume, and mix of products. It is useful for determining the amount of units or total sales revenue the company must earn at a particular level of profit desired. CVP analysis is based on the on the profit equation:
Sales Revenue - Variable costs - Fixed costs = Profit
SPx – VCx – FC = Profit
Where SP = sales price per unit
VC = variable cost per unit
FC = total fixed costs
x = number of units
In most situations, you will solve for x, the number of units. Note the format of the equation includes the components of the variable costing income statement. Although some textbooks provide specific formulas, the formulas are not very flexible. The profit equation approach is easier to remember given that you already know the income statement format. The key is to remember that selling price and variable costs are in units and fixed cost is a total. Total sales revenue is determined after you solve for the number of units to be sold. If you buy 3 beers at an NFL football game for $8 each, sales revenue for the vendor at the stadium will be 3 times $8, or $24.
Assumptions in CVP Analysis
When relying on analysis using CVP, we must remember four assumptions so we can understand the limitations of the analysis: The assumptions are:
a. Costs can be accurately separated into their variable and fixed components.
b. Both unit variable costs and total fixed costs remain constant within the relevant range.
c. Inventory levels are zero or do not change.
d. Costs are linear.... [continues]
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