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Concept
Cost–volume–profit analysis
Summary
Cost–volume–profit (CVP), in managerial economics, is a form of cost accounting. It is a simplified model, useful for elementary instruction and for short-run decisions.
A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this break-even point, a company will experience no income or loss. This break-even point can be an initial examination that precedes a more detailed CVP analysis.
CVP analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are:
The behavior of both costs and revenues is 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 product mix (the ratio of each product to total sales) will remain constant.
The components of CVP analysis are:
Level or volume of activity.
Unit selling prices
Variable cost per unit
Total fixed costs
Manpower Cost Direct and indirect
CVP assumes the following:
Constant sales price;
Constant variable cost per unit;
Constant total fixed cost;
Units sold equal units produced.
These are simplifying, largely linearizing assumptions, which are often implicitly assumed in elementary discussions of costs and profits. In more advanced treatments and practice, costs and revenue are nonlinear, and the analysis is more complicated, but the intuition afforded by linear CVP remains basic and useful.
One of the main methods of calculating CVP is profit–volume ratio, which is (contribution /sales)*100 = this gives us profit–volume ratio.
Contribution stands for sales minus variable costs.
Therefore, it gives us the profit added per unit of variable costs.
Official source
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