Cost-Volume-profit (CVP), in managerial economics is a form of cost accounting.

It is a simplified model, useful for elementary instruction and for short-run decisions. Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point (BEP), a company will experience no income or loss. This BEP can be an initial examination that precedes more detailed CVP analysis. Cost-volume-profit analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are: The behavior of both costs and revenues is linear throughout the relevant range of activity. (This assumption precludes the concept of volume discounts on either purchased materials or sales.) Costs can be classified accurately as either fixed or variable. Changes in activity are the only factors that affect costs. All units produced are sold (there is no ending finished goods inventory). When a company sells more than one type of product, the sales mix (the ratio of each product to total sales) will remain constant. The components of Cost-Volume-Profit Analysis are:

Level or volume of activity Unit Selling Prices Variable cost per unit Total fixed costs Sales mix

Assumptions
CVP assumes the following:

Constant sales price; Constant variable cost per unit; Constant total fixed cost; Constant sales mix; Units sold equal units produced.

These are simplifying, largely linearizing assumptions, which are often implicitly assumed in elementary discussions of costs and profits. In more advanced treatments and practice, costs and revenue are nonlinear and the analysis is more complicated, but the intuition afforded by linear CVP remains basic and useful. One of the main Methods of calculating CVP is Profit volume ratio: which is (contribution /sales)*100 = this gives us profit volume ratio.

contribution stands for Sales minus variable costs.

Therefore it gives us the profit added per unit of variable costs. CVP analysis may be helpful for the following tasks: 1. To forecast profit by considering the relationship between cost and profit on one hand, and production volume on the other 2. To prepare a flexible budget showing costs at different levels of production 3. To help evaluate a start-up operation 4. To evaluate performance for the purpose of benchmarking and control 5. To set pricing policies by projecting the effect of different price structures on cost and profit CVP analysis requires certain information to be available before analysis can be performed. The information needed in CVP analysis is as follows:

Amounts of variable and fixed costs Sales price per unit Desired level of profit (or loss)

CVP analysis is subject to a number of assumptions. Although these assumptions do not negate the usefulness of CVP models, especially for a single product or service, they do suggest the need for further analysis before plans are finalized. Among the more important assumptions are: 1. All costs are classified as fixed or variable with unit level activity cost drivers. This assumption is most reasonable when analyzing the profitability of a specific event (such as a concert) or the profitability of an organization that produces a single product or service on a continuous basis. 2. The total cost function is linear within the relevant range. This assumption is often valid within a relevant range of normal operations, but over the entire range of possible activity, changes in efficiency are likely to result in a curvilinear cost function. 3. The total revenue function is linear within the relevant range. Unit selling prices are assumed constant over the range of possible volumes. This implies a purely competitive market for final products or services. In some economic models in which demand responds to price changes, the revenue function is curvilinear. In these situations, the linear approximation is accurate only within a limited range of activity. 4. The analysis is for a single product, or the sales mix of multiple products is constant. The sales mix refers to the relative portion of unit or dollar sales derived from each product or service. If products have different selling prices and costs, changes in the mix affect CVP model results. 5. There is only one activity cost driverunit or dollar sales volume. The traditional unit-level

approach of CVP analysis does not consider other types of cost drivers (batch, product, customer, and so forth). As seen in Chapter 2, this is a limiting assumption, especially in complex organizations with multiple products. Under such circumstances, it is seldom possible to represent the multitude of factors that drive costs for an entire organization with a single cost driver. When applied to a single product (such as pounds of potato chips), service (such as the number of pages printed), or event (such as the number of tickets sold to a concert), it is reasonable to assume the single independent variable is the cost driver. The total costs associated with the single product, service, or event during a specific time period are often determined by this single activity cost driver. Although cost-volume-profit analysis is often used to understand the overall operations of an organization or business segment, accuracy decreases as the scope of operations being analyzed increases. After introducing profitability analysis with only a single unit-level cost driver, we expand discussion of profitability analysis to include multiple unit-level cost drivers and, finally, a hierarchy of cost drivers. Cost volume profit analysis (CVP analysis) is one of the most powerful tools that managers have at their command. It helps them understand the interrelationship between cost, volume, and profit in an organization by focusing on interactions among the following five elements: 1. 2. 3. 4. 5. Prices of products Volume or level of activity Per unit variable cost Total fixed cost Mix of product sold

Because cost-volume-profit (CVP) analysis helps managers understand the interrelationships among cost, volume, and profit it is a vital tool in many business decisions. These decisions include, for example, what products to manufacture or sell, what pricing policy to follow, what marketing strategy to employ, and what type of productive facilities to acquire. Contribution Margin and Basics of CVP Analysis Difference Between Gross Margin and Contribution Margin Cost Volume Profit (CVP) Relationship in Graphic Form Contribution Margin Ratio (CM Ratio) Importance of Contribution Margin

Applications of Cost Volume Profit (CVP) Concepts:

Now we can explain how CVP concepts developed on above pages can be used in planning and decision making. We shall use these concepts to show how changes in variable costs, fixed costs, sales price, and sales volume effect contribution margin

and profitability of companies in a variety of situations. For detailed study click on a link below. Change Change Change Change Change in in in in in fixed cost and sales volume variable cost and sales volume fixed cost, sales price and sales volume variable cost, fixed cost, and sales volume regular sales price