The cost profit analysis (CVP) determines how cost and volume affect a company’s operating income. To successfully perform the analysis the five basic components have to be known. The components are volume or level of activity, unit selling prices, variable cost per unit, total fixed cost, and sales mix. Volume or level of activity is how many units are produced or sold. The unit selling prices are the cost that each unit produced is sold or thought to be sold will sale for. The variable cost per unit means that the cost of each unit produced or sold may change depending on the activity level. Different variable cost, fixed cost remain the same in total, regardless of changes in activity level. Sales mix is the proportions of sales coming from different products or services. Changes in the sales mix can affect profits because different products have different profit margins, this can cause a change the sales mix and can have a impact on profits, even when total revenues are unchanged. Based on theses formulas, when the unit selling price increases the contribution margin per unit causes the net income to be increased. The following will illustrate how the increase in the unit price can affect the contribution margin. Table 1
CVP Income Statement Month Ending December 31, 2009
Sales per unit $5.00
Variable cost $1.50
Contribution margin $3.50
Contribution margin $3.50/$5.00 unit selling price equals the contribution margin ratio. 70% is the contribution margin ratio.
The contribution margin ratio is the contribution margin per unit divided by the unit selling price. If any of the components change, the contribution ratio either increases or decreases the net income. All of these components are important in the accounting of a business because they can affect your profits either positively or negatively.