Cost-Volue-Profit analysis

Cost Value Profit analysis

Some of the most significant decisions to be made in financial management are those concerning to pricing; the prices must be high enough to cover all costs and offer a profit. Cost-volume-profit (CVP) analysis is a technique that examines changes in profits in response to changes in sales volumes, costs, and prices. Accountants often perform CVP analysis to plan future levels of operating activity and provide information about product and services. Cost-volume-profit analysis is used to help us how changing volumes of sales or revenue affect profits. The foundation of this analysis is the calculation of break-even point and understanding how profit will vary with a change in the volume of sales.

The contribution margin is the selling price of the product less its variable cost. However, it is often helpful to deal with a ratio containing this information, rather than an amount of money. Not surprisingly, this ratio is called the contribution margin ratio. The contribution margin ratio is the contribution margin expressed as a percentage of sales revenue',

The break-even point is defined as the point where sales or revenues equal expenses'. There is no profit made or loss incurred at the break-even point. This figure is important for anyone that directs a business since the break-even point is the lower limit of profit when setting prices and determining margins; if the break-even point is not achieved, that business will (or should) finally go out of business. Clearly the break-even point becomes very significant when calculating a strategy for net profit. Deal (1999-2003)

The margin of safety is the amount of sales above the break-even point. This measure specifies how far sales can fall before a loss takes place; it requires knowing when the buying price is low in absolute terms rather than merely relative to the market ...