Cost-Volume-Profit Analysis
Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point (BEP), a company will experience no income or loss. This BEP can be an initial examination that precedes more detailed CVP analyses.
Cost-volume-profit analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are:
- The behavior of both costs and revenues in linear throughout the relevant range of activity. (This assumption precludes the concept of volume discounts on either purchased materials or sales.)
- Costs can be classified accurately as either fixed or variable.
- Changes in activity are the only factors that affect costs.
- All units produced are sold (there is no ending finished goods inventory).
- When a company sells more than one type of product, the sales mix (the ratio of each product to total sales) will remain constant.
In the following discussion, only one product will be assumed. Finding the breakeven point is the initial step in CVP, since it is critical to know whether sales at a given level will at least cover the relevant costs. The breakeven point can be determined with a mathematical equation, using contribution margin, or from a CVP graph.
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