Cost-Volume-Profit Analysis: Definition
Cost-volume-profit (CVP) analysis is a technique used to determine the effects of changes in an organization’s sales volume on its costs, revenue, and profit.
CVP analysis is also used to analyze the effects on profit of various factors, namely:
- Changes in selling prices
- Income tax rates
- Organization’s mix of products or services
Cost-Volume-Profit Analysis: Explanation
To profit is the first law of any business enterprise.
If profit isn’t there, the enterprise is liable to be eliminated. However, very few managers know about the profit structure in their own company or the basic elements that determine the profit structure.
Cost-volume-profit (CVP) analysis is an important tool that analyzes the interplay of various factors that affect profits.
CVP analysis shows the relationships among a business’s costs, volume, and profits. It is an important part of an organization’s budgeting activities.
CVP analysis is a tool used extensively in both the planning and control functions of an organization. An organization may use CVP analysis as a planning tool when the management wants to find out the desired profit when the sales volume is known.
Alternatively, the management may begin with a target profit and then work out the level of sales needed to reach that profit level.
As a control technique, CVP analysis is used to measure the performance of the different departments in a company.
A basic application of CVP analysis is break-even analysis. Break-even analysis is concerned with determining the sales volume at which total revenue equals total costs so that profits are seen.
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