Question

Cost-volume-profit analysis, or CVP, is something companies use to figure out how changes in costs and volume affect their operating expenses and net income. In other words, CVP is a methodical analysis of the dynamic inter-relationship between selling prices, sales and production volume, cost expenses, and profits.

Respond to the following in a minimum of 175 words:

• Explain each of the three elements of CVP analysis.
• Discuss how managers use CVP analysis.

Answer 1

Cost-volume-profit analysis, or CVP, is something companies use to figure out how changes in costs and volume affect their operating expenses and net income. In other words, CVP is a methodical analysis of the dynamic inter-relationship between selling prices, sales and production volume, cost expenses, and profits.

The cost-volume-profit formula is:

Selling price−variable costs−fixed costs=profit

The cost-volume profit analysis requires three vital elements to make an accurate result. Those elements are activity level, variable cost per unit, and the total fixed cost.

1) The activity level is the total units that were sold in the analysed period. This measurement will give us the exact amount of the final product that was sold during the month, quarter, semester, or year that is required to be evaluated.

2) Variable costs per unit sold must include all the variables expenses that must be applicable to each item that was sold. This data may include variable cost like direct materials and sales commissions incurred during the evaluated period.

3) Total fixed costs of the company within the evaluated period. This expenditure may be pretty steady from period to period. However, sometimes management decides to include some step cost from a new cost generated from a change in the activity level.

Managers use CVP analysis to quote how many changes are in the company's costs, for fixed and variable costs, the volume in sales, and the price of the final products, that affect the company's profit. The CVP is a very helpful tool for management in finance and accounting departments that helps make proper decisions.

In completing the CVP analysis one must assume there is no change in the price of a good/service, if multiple goods are sold the amount is consistent, and that pricing matches quantity (the amount is linear). Managers typically utilize the CVP analysis in decision making. In some cases, leadership must decide how to allocate resources and plan for production goals. For example, the CVP provides valuable insight on the break-even point in term of units which means they would determine the amount of produced needed to cover operational cost. In many businesses, management determines this information to secure the financial wellness of the organization in both the short-term and long-term in accordance to shifts in operational cost.