Cost, Volume and Running head: COST, VOLUME AND PROFIT FORMULAS

Cost, Volume and Profit Formulas Student Name College Name

Cost, Volume and Profit Formulas The CVP Analysis or (Cost-Volume-Profit Analysis) is best described as a tool used for determining the changes in cost and volume and how that affects the net income and operating income of the company. The components of the CVP are the volume or level of activity, the units selling price, the variable cost per unit, the total fixed cost for the company, and the sales mix, that is if the company sales more than one item (Thakkar, Finley, & Liao, 1984, p. 1). The volume or level of activity is the amount of sales the company has for any given period. If in period 5 they had a record breaking period and sold 50,000 units and then in period 6 they dropped down to 30,000 units this would be the level of activity. The unit selling price is just what it sounds like, the price the company has decided on to sell the product. If they decide on $25 than this is what the unit selling price would be. The variable cost per unit are those cost that stay fixed on a per unit basis but actually change depending on the level of activity. So now we sell the product for $25 a unit and the variable cost is now set at $10 a unit. The total fixed cost for the company is fixed in total; however they change depending on the level of activity. The company pays $5,000 a month for rent; this will always stay the same. However the more units the company makes the lower the fixed costs per unit get. Meaning that when they produce 1,000 units the fixed cost of the unit is $5, now if they produce 10,000 units the fixed price of the units becomes $1 per unit. The sales mix is only used if the company sells more than one type of unit, such as 500 watt stereo speakers and 1000 watt stereo speakers. If this is relevant to the company then they need to take a relative percentage of the two in order to make their sales mix.

Now, earlier I mentioned a unit cost of $25 and a variable cost of $10, this allows for the contribution margin of $15 per unit. If the company decided to raise the price per unit to $30 a unit then the contribution margin would also go up, now they have a contribution margin of $20 per unit. Even though the selling price of the unit goes up the variable cost of the unit stays the same. Contribution Margin Ratio is the contribution margin per unit divided by the unit selling price. In other words it would look like this, the contribution margin per unit ($20) divided by the unit selling price ($30) equals the contribution margin ratio or (66.67%). The contribution ratio can change if there are changes in other areas, for instance if the company was to raise their price again but the contribution margin was to remain the same the contribution ratio would decline. An example of this is the contribution margin (CM) = $20 divided by the selling price (SP) = $35 the contribution ratio (CR) would now be 57.14%. Also if the CM was to change and the SP was to stay the same the CR would also change. An example would be CM=$10 divided by SP=$30 the CR would now be 33.33%. One good way to find a companys breakeven point is by finding out how many units they need to produce. If the company has a fixed cost of $5,000 and the unit contribution margin is $10 than we write the formulation out like this, breakeven point is y=500010 where y represents the units needed for the company to breakeven or y=500 units (Finley, Liao, 1981, p. 1). Now if the fixed costs were to change or decrease to $4,000 then the units needed for the company to break even drops to 400 units.

Reference THAKKAR, R., FINLEY, D., & LIAO, W. (1984). A Stochastic demand CVP model with return on investment criterion. Contemporary Accounting Research, 1(1), 77-86. Retrieved from Business Source Complete database. Finley, D., & Liao, W. (1981). A General Decision Model for Cost-Volume-Profit Analysis Under Uncertainty: A Comment. Accounting Review, 56(2), 400. Retrieved from Business Source Complete database.