What is CVP Analysis?

Cost-Volume-Profit Analysis (CVP analysis), also commonly referred to as Break-Even An

(both variable and fixed) and sales volume affect a company’s profit. With this informat
at how many units must be sold to break even or to reach a certain profit threshold or

Components of CVP Analysis

There are several different components that together make up CVP analysis.  These co
down in more detail in this guide.

The main components of CVP analysis are:

1. CM ratio and variable expense ratio

2. Break-even point (in units or dollars)
3. Margin of safety
4. Changes in net income
5. Degree of operating leverage

In order to properly implement CVP analysis, we must first take a look at the contributi

CVP Analysis Setup

The regular income statement follows the order of revenues minus cost of goods sold
income. A contribution margin income statement follows a similar concept but uses a d
The contribution margin is the product’s selling price, less the variable costs associated
per unit.

Contribution Margin (CM) Income Statement Example:

Consider the following example in order to calculate the five important components lis

XYZ Company has the following contribution margin income statement:

Sales (20,000 units)

Less: Variable costs
Contribution Margin
Less: Fixed costs
Net income

#1 CM Ratio and Variable Expense Ratio

CM ratios and variable expense ratios are numbers that companies generally want to s

CM Ratio = Contribution Margin / Sales

Variable Expense Ratio = Total Variable Costs / Sales

A high CM ratio and a low variable expense ratio indicate low levels of variable costs inc

#2 Break-Even Point
The break-even point (BEP), in units, is the number of products the company must sell
is the amount of sales the company must generate to cover all production costs (variab

The formula for break-even point (BEP) is:

BEP =Total Fixed Costs /  CM per Unit

The BEP, in units, would be equal to 240,000/15 = 16,000 units. Therefore, if the compa
“break even” and only cover its production costs.

#3 Changes in Net Income (What-if Analysis)

It is quite common for companies to want to estimate how their net income will change
sales performance targets or net income targets to determine their effect on each othe

In this example, if management wants to earn a profit of at least $100,000, how many u

We can apply the appropriate what-if formula below:

No. of units = (Fixed Costs + Target Profit) / CM Ratio

Therefore, to earn at least $100,000 in net income, the company must sell at least 22,66

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#4 Margin of Safety

In addition, companies may also want to calculate the margin of safety. This is common
much sales can drop and yet still break even.

The formula for the margin of safety is:

Margin of Safety = Actual Sales – Break-even Sales

The margin of safety in this example is:

Actual Sales – Break-even Sales = $1,200,000 – 16,000*$60 = $240,000

This margin can also be calculated as a percentage in relation to actual sales: 240,000/1

Therefore, sales can drop by $240,000, or 20%, and the company is still not losing any m

#5 Degree of Operating Leverage (DOL)

Finally, the degree of operating leverage (DOL) can be calculated using the following fo

DOL = CM / Net Income

So, the DOL in this example is $300,000 / 60,000 = 5.

The DOL number is an important number because it tells companies how net income c
number 5 means that a 1% change in sales will cause a magnified 5% change in net inc

Many might think that the higher the DOL, the better for companies. However, the high
that a 1% decrease in sales will cause a magnified, larger decrease in net income, ultim

CVP Analysis and Decision Making

Putting all the pieces together and conducting the CVP analysis, companies can then m
alter their cost structures, and determine the effects on sales and profitability much qu
For example, let’s say that XYZ Company from the previous example was considering in
per unit but could decrease fixed costs by $30,000. In this decision-making scenario, co
determine the best answer.

The hardest part in these situations involves determining how these changes will affect
will they go down? Once sales estimates become somewhat reasonable, it then becom
profitability.
Total Per Unit

### $60
### ($45)
### $15
###
$60,000