Cost-Volume-Profit Flashcards
What is Cost-Volume-Profit analysis?
Cost-Volume-Profit (CVP) analysis is a tool that helps businesses understand how changes in sales volume, costs, and prices affect profitability. It’s widely used for decision-making in pricing, cost control, and production planning.
Why is Cost-Volume-Profit analysis important?
CVP analysis is essential because it:
1. Identifies break-even points and profitability levels.
2. Helps set sales and production targets to meet financial goals.
3. Evaluates the impact of cost structure changes on profit.”
What are the key elements of Cost-Volume-Profit analysis?
- Selling Price per Unit
- Variable Cost per Unit
- Fixed Costs
- Sales Volume
- Product Mix (if multiple products are sold)
What is a break-even analysis?
Break-even analysis determines the sales volume at which total revenue equals total costs (profit = 0).
Break-even units = Total Fixed Costs / Contribution Margin per Unit
What is a target profit analysis?
Target profit analysis calculates the sales volume needed to achieve a specific profit level.
Target units =
(Total Fixed Costs + Target profit) / Contribution Margin per Unit
What is the margin of safety?
The margin of safety measures how much sales can drop before the company reaches the break-even point.
Margin of safety = Actual sales - Break-even sales
Margin of safety ratio = Margin of safety / Actual Sales
If the Margin of Safety Ratio is 20%, it means sales can decline by 20% before the company reaches its break-even point.
What is the contribution margin ratio?
The contribution margin Ratio shows the percentage of sales available to cover fixed costs and generate profit.
Contribution margin ratio =
Contribution margin / Sales revenue
What decision can manager make from Cost-Volume-Profit Analysis?
- Product Selection: Identify profitable products.
- Pricing Strategies: Set prices to achieve target profits.
- Cost Management: Optimize fixed and variable costs to improve profitability.
- Sales Planning: Determine the sales volume needed to meet profit goals.
How does the break-even, target profit, margin of safety, and contribution margin formulas work together?
How These Formulas Work Together
* Break-Even Formula: Establishes the baseline (no profit, no loss).
- Contribution Margin: The building block for understanding profitability at the unit level.
- Target Profit Analysis: Extends the break-even formula to include profit goals.
- Margin of Safety: Assesses the risk of sales shortfalls.
- CM Ratio: Adds a percentage perspective, useful for decision-making.
How can Cost-Volume-Profit analysis help managers calculate discounts and special orders?
When offering a discount, CVP helps determine if the lower selling price will still cover costs and maintain profitability. The focus is on ensuring that the contribution margin remains sufficient to cover fixed costs and generate profit.
Special orders are one-time orders offered at a price lower than the usual selling price, often to utilize unused capacity or gain strategic benefits. CVP helps by calculating the profitabillity of the special order.
What are some key considerations for Cost-Volume-Profit Analysis?
Key Considerations
1. Capacity: Ensure the business has enough capacity to fulfill special orders without disrupting regular production.
- Long-Term Implications:
Discounts may set customer expectations for lower prices.
Special orders at reduced prices shouldn’t cannibalize regular sales. - Fixed Costs: Since fixed costs are already accounted for, focus on whether the incremental contribution margin is positive.
