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Cost-Volume-Profit Relationship

CVP analysis

Cost-Volume-Profit Relationship
Cost-Volume-Profit (CVP) analysis is a powerful tool that helps managers understand the relationships among cost, volume, and profit. This analysis is based upon 5 key factors that could affect profit.

1. Selling prices 2. Sale Volume 3. Unit Variable Cost 4. Total Fixed Costs 5. Mix of Products Sold

5-key factors of CVP

The Selling Price

The Selling price is determined by the market clearing price (Economics) in a free market society.

Sale Volume is determined by consumers demand in a free market society.

Sale Volume

Unit Variable Costing

Unit Variable Costing= variable cost/units sold. Variable costs are costs that vary with output.
EX- The more amount of gum you buy for $1.50 the more the cost is. This is because the variable unit cot is $1.50 and additional gum is going to add to your total price.

Total costs: are the costs that are going to be incurred in a business no matter what. Even if the business fails to sell a single product or provide a single service, they would still have to incur a fixed cost.
EX. Fixed costs include rent, utilities, advertisement, etc.

Total Fixed Costs

Mix Product Cost

Mix product is a something that has both fixed and variable costs. The best way to describe the relationship of a mix product cost is through an algebraic equation of Y=Mx+B (Y=Mix Product cost, M=variable cost, and B= fixed costs)

In order to properly see the mixed and variable costs of a business one would have to show a contribution format income statement. Unlike the traditional income statement a contribution format helps us see the total variable and fixed expenses in a business.

Contribution Income Statement

Contribution Format Vs. Report Format

Profit= (sales-Variable Expenses)-Fixed Expenses

Contribution Equation

Break-Even Point
Break-even unit defines the amount of product or service that a business would have to get in order to cover all the fixed costs and end up at $0 (normal profit). With this equation a business would neither have a loss or a profit; they would have enough to cover their fixed costs.

Target profit is different from a breakeven point in that, it is reaching for a profit of more than $0. Target profit analysis helps a manager understand the amount of units the business would need to sell in order to gain a desired profit.

Target Profit

Both Target profit and break-even unit will be found using the contribution equation. CVP can help a manger and a business owner budget in order to get to a desired goal. For this reason it is imperative that a business manager and owner understand the fixed and variable costs of their business.

Personal Connection
What are some variable costs that you would have to experience in college? What are some fixed costs that you would have to account for in college? How could going to college yield a profit? (Hint: would you able to earn more money by going to school?)

Have you ever thought of college? What do you want to go to school for and why? Research How much more money does a person with a bachelor get in comparison to someone with a high school diploma. How much more does someone with a higher education get in comparison to someone with a bachelor degree?