Lesson 33 - Intermediate Accounting Course 

33. Cost-Volume-Profit (CVP) Analysis and Decision Making

Cost-Volume-Profit (CVP) analysis is a powerful financial tool that helps businesses understand how costs, sales volume, and profits interact. It is crucial for pricing strategies, profit planning, and business decision-making.

1️⃣ What Is CVP Analysis?

CVP analysis helps businesses determine:
✔ Break-even point (the sales level at which total revenue equals total costs).
✔ Target profit levels (how many units must be sold to achieve a desired profit).
✔ Impact of cost changes (how fixed and variable costs affect profits).
✔ Effect of sales mix changes (which product combinations maximize profit).

It is based on the relationship between sales price, variable costs, fixed costs, and sales volume.

2️⃣ Key Components of CVP Analysis

To perform a CVP analysis, we need to understand these key components:

✔ 1. Sales Revenue

Total income from selling goods or services:

✔ 2. Variable Costs

Costs that change proportionally with production volume (e.g., raw materials, direct labor, shipping costs).

✔ 3. Fixed Costs

Costs that do not change with production levels (e.g., rent, salaries, insurance).

✔ 4. Contribution Margin (CM)

The amount remaining after subtracting variable costs from sales revenue. This covers fixed costs and generates profit.

Example: If a product sells for $50 and has a variable cost of $30, the contribution margin is: 

3️⃣ Break-Even Analysis

The break-even point is the sales volume at which total revenue equals total costs, meaning zero profit or loss.

✔ Break-Even Formula:

Example:
A business has:

• Fixed costs = $10,000
  
  

• Selling price per unit = $50
  
  

• Variable cost per unit = $30
  
  

• Contribution margin per unit = $20

So, the company must sell at least 500 units to break even.

4️⃣ Target Profit Analysis

To determine how many units must be sold to achieve a specific profit goal, we modify the break-even formula:

Example:

If a company wants a profit of $5,000, with the same fixed costs and contribution margin as before: 

So, the company must sell 750 units to make a $5,000 profit. 

5️⃣ CVP and Decision Making

CVP analysis is useful for various business decisions:

✔ 1. Pricing Decisions

• If costs increase, should the selling price be increased?
  
  

• How does a price reduction affect profit?
  
  

✔ 2. Cost Control & Profitability

• How will reducing fixed costs affect the break-even point?
  
  

• Can we switch to lower variable costs without reducing quality?
  
  

✔ 3. Sales Mix Optimization

• If a company sells multiple products, which mix maximizes total profit?
  
  

✔ 4. Evaluating New Investments

• If we buy new equipment (which increases fixed costs but lowers variable costs), how will it impact profits?

6️⃣ Multi-Product CVP Analysis

If a company sells multiple products, the sales mix (proportion of each product sold) affects profitability.

Companies can use this to calculate a combined break-even point. 

7️⃣ Assumptions of CVP Analysis

1. Selling price per unit remains constant (no volume discounts).
   
   

2. Costs are either fixed or variable (no semi-variable costs).
   
   

3. Sales volume is the only factor affecting costs and revenue.
   
   

4. All units produced are sold (no inventory buildup).
   
   

While real-world scenarios are more complex, CVP still provides a useful approximation for decision-making.

8️⃣ Summary & Key Takeaways

✔ CVP analysis helps businesses understand the relationship between cost, volume, and profit.
✔ The break-even point is the number of units a company must sell to cover all costs.
✔ Contribution margin helps businesses determine profitability per unit.
✔ Target profit analysis determines the number of sales needed to achieve a profit goal.
✔ CVP analysis aids in pricing, cost control, and profitability decisions.

By using CVP analysis, businesses can optimize pricing, reduce costs, and improve profit margins.