What
Cost/Volume/Profit (CVP) Analysis Can Do For Your Business
Too many businesses operate in the dark. Unaware of the impact that basic decisions have on the rest of their business, they blindly make haphazard choices and clean up the mess later. Your cost/volume/profit (CVP) analysis gives you the insight you need to make the right choices and avoid costly mistakes.
These are some of the things your CVP analysis can tell you:
The most profitable product or service you offer
Which products or services should be emphasized
What sales volumes you need to meet in order to stay profitable
Sales goals you will need to meet in order to cover any increase in fixed costs (i.e. an increase in rent)
The increase in sales you’ll need to compensate for any discounting
To make the most of your CVP analysis, you must first understand your fixed costs and your variable costs.
Fixed Costs
Fixed costs are those costs that remain the same no matter what volume of sales your business has.
This includes rent, insurance, licenses, wages for permanent employees, interest on loans and operational expenses.
Variable Costs
Variable costs are directly related to your sales levels in dollars or units sold. For example, materials and supplies, commissions on sales, sales incentives or bonuses for employees and shipping costs are all considered variable costs.
While your accountant can help you ascertain which of your costs are fixed and which are variable, you or someone who is very familiar with your business will need to make the final determination. This can get tricky but to assist you, here are some further explanations of costs.
Combination Costs
There may be times when a minimum level of cost will be incurred regardless of sales levels but the costs rise as your volume increases. You will need to determine the most important type of cost. For example, you may pay a flat fee for being able to process credit card purchases and an additional fee for each charge processed. If the cost of processing each charge is greater than the monthly flat fee, you would classify this as a variable cost.
Relevant Range of Activity
Your CVP analysis is only relevant or valuable when you consider it within a range of sales that is reasonably expected for your business. Likewise, fixed costs only remain fixed over a certain period of time or within a relevant range of activity. Think about your insurance, it may become more or less expensive with time. If your CVP parameters are not clearly set in terms of volume of sales and period of time, your results will not be useful.
Cost Per Unit or Job
To arrive at this number, add up all your variable costs for the designated accounting period then divide by the number of units sold. Service providers may want to use the number of jobs or hours spent on the jobs instead of units sold. The cost per unit or job does not fluctuate and can be useful when coming up with bids for projects.
Classifying your costs is critical to coming up with a successful CVP analysis. Your CVP analysis offers three critical types of information:
What Sales Volume Do You Need to Achieve Breakeven?
A breakeven analysis tells you the sales volume you need to reach under different pricing strategies and cost scenarios so that your business can breakeven.
Which Products or Services are the Most Valuable?
A contribution margin analysis compares your different products and services and their overall profitability. Using this information, you can resolve which products to promote strongly and which products you may want to discontinue.
How Your Fixed Costs Impact Your Bottom Line
An operating leverage report lets you examine the effects of increasing or decreasing the role of fixed costs in your operating structure.