cost volume profit analysis research paper

Management and Cost Accounting pp 205–235 Cite as

Cost-volume-profit analysis

• Colin Drury 2  

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After studying this chapter, you should be able to:

describe the differences between the accountants’ and the economists’ model of cost—volume—profit analysis;

justify the use of linear cost and revenue functions in the accountants’ model;

apply the mathematical approach to answer questions similar to those listed on pages 213 and 214 in respect of Exhibit 9.1;

construct break-even, contribution and profit—volume graphs;

identify and explain the assumptions on which cost—volume—profit analysis is based;

calculate break-even points for multi-product situations.

• Variable Cost
• Output Level
• Selling Price
• Total Revenue

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References and Further Reading

Anderson, L.K. (1975) Expanded break-even analysis for a multi-product company, Management Accounting (USA) , July, 30–2.

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Broster, E.J. (1971) The role of price elasticity of demand in profit planning, Journal of Business Finance , Autumn, 18–27.

Cooper, R. and Kaplan, R.S. (1987) How cost accounting systematically distorts product costs, in Accounting and Management: Field Study Perspectives (eds W.H. Bruns and R.S. Kaplan ), Harvard Business School Press, Ch. 8.

Dean, J. F. (1949) Cost structures of enterprise and break-even techniques, American Economic Review , May, 150–60.

Dorward, N. (1986) The mythology of constant marginal costs, Accountancy , April, 98–102.

Gambling, T.E. (1965) Some observations on break-even budgeting and programming to goals, Journal of Accounting Research 3 (1), Spring, 159–65.

Ghosh, B.C. (1980) Fixed costs in break-even analysis, Management Accounting , May, 50–1.

Givens, H.R. (1966) An application of curvilinear break-even analysis, The Accounting Review , 41 (1), January, 141–3.

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Manes, R. (1966) A new dimension to break-even analysis, Journal of Accounting Research , 4 (1), Spring, 87–100.

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Middleton, K. (1980) A critical look at break-even analysis, Australian Accountant , May, 264–8.

Richardson, A.W. (1978) Some extensions with the application of cost-volume-profit analysis, Cost and Management , September/October, 30–35.

Scapens, R.W. (1985) Management Accounting: A Review of Contemporary Developments , Macmillan, Ch. 5.

Sinclair, K.P. and Talbott, J.A. (1986) Using breakeven analysis when cost behaviour is unknown, Management Accounting (USA) , July, 52–6.

Singh, P.S. and Chapman, G.L. (1978) Is linear approximation good enough?, Management Accounting (USA) , January, 53–5.

Solomons, D. (1974) Break-even analysis under absorption costing, in Information for Decision-making (ed. A. Rappaport ), Prentice-Hall, pp. 100–104

Vickers, D. (1960) On the economics of break-even. The Accounting Review 35 (3), July, 405–12; also in Contemporary Issues in Cost and Management Accounting (eds H.R. Anton, P.A. Firmin, and H.D. Grove ), Houghton Mifflin (1978), pp. 272–82.

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Colin Drury ( Reader in Accountancy and Finance )

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Drury, C. (1992). Cost-volume-profit analysis. In: Management and Cost Accounting. Springer, Boston, MA. https://doi.org/10.1007/978-1-4899-6828-9_9

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• Corporate Finance

Cost-Volume-Profit (CVP) Analysis: What It Is and the Formula for Calculating It

Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.

What Is Cost-Volume-Profit (CVP) Analysis?

Cost-volume-profit (CVP) analysis is a method of cost accounting that looks at the impact that varying levels of costs and volume have on operating profit.

Key Takeaways

• Cost-volume-profit (CVP) analysis is a way to find out how changes in variable and fixed costs affect a firm's profit.
• Companies can use CVP to see how many units they need to sell to break even (cover all costs) or reach a certain minimum profit margin.
• CVP analysis makes several assumptions, including that the sales price, fixed, and variable costs per unit are constant. 

Investopedia / Daniel Fishel

Understanding Cost-Volume-Profit (CVP) Analysis

The cost-volume-profit analysis, also commonly known as breakeven analysis, looks to determine the  breakeven point for different sales volumes and cost structures plotted on a profit-volume chart , which can be useful for managers making short-term business decisions. CVP analysis makes several assumptions, including that the sales price, fixed and variable costs per unit are constant. Running a CVP analysis involves using several equations for price, cost, and other variables, which it then plots out on an economic graph.

The CVP formula can also calculate the breakeven point. The breakeven point is the number of units that need to be sold or the amount of sales revenue that has to be generated in order to cover the costs required to make the product. The CVP breakeven sales volume formula is:

Breakeven Sales Volume = F C C M where: F C = Fixed costs C M = Contribution margin = Sales − Variable Costs \begin{aligned} &\text{Breakeven Sales Volume}=\frac{FC}{CM} \\ &\textbf{where:}\\ &FC=\text{Fixed costs}\\ &CM=\text{Contribution margin} = \text{Sales} - \text{Variable Costs}\\ \end{aligned} ​ Breakeven Sales Volume = CM FC ​ where: FC = Fixed costs CM = Contribution margin = Sales − Variable Costs ​

To use the above formula to find a company's target sales volume, simply add a target profit amount per unit to the fixed-cost component of the formula. This allows you to solve for the target volume based on the assumptions used in the model.

CVP analysis also manages product contribution margin. The contribution margin is the difference between total sales and total variable costs. For a business to be profitable, the contribution margin must exceed total fixed costs. The contribution margin may also be calculated per unit. The unit contribution margin is simply the remainder after the unit variable cost is subtracted from the unit sales price. The contribution margin ratio is determined by dividing the contribution margin by total sales.

The contribution margin is used to determine the breakeven point of sales. By dividing the total fixed costs by the contribution margin ratio, the breakeven point of sales in terms of total dollars may be calculated. For example, a company with $100,000 of fixed costs and a contribution margin of 40% must earn revenue of $250,000 to break even.

Profit may be added to the fixed costs to perform CVP analysis on the desired outcome. For example, if the previous company desired a profit of $50,000, the necessary total sales revenue is found by dividing $150,000 (the sum of fixed costs and desired profit) by the contribution margin of 40%. This example yields a required sales revenue of $375,000.

Special Considerations

CVP analysis is only reliable if costs are fixed within a specified production level. All units produced are assumed to be sold, and all fixed costs must be stable in CVP analysis. Another assumption is all changes in expenses occur because of changes in activity level. Semi-variable expenses must be split between expense classifications using the high-low method , scatter plot, or statistical regression.

How Is Cost-Volume-Profit (CVP) Analysis Used?

Cost-volume-profit analysis is used to determine whether there is an economic justification for a product to be manufactured. A target profit margin is added to the breakeven sales volume, which is the number of units that need to be sold in order to cover the costs required to make the product and arrive at the target sales volume needed to generate the desired profit. The decision maker could then compare the product's sales projections to the target sales volume to see if it is worth manufacturing.

What Assumptions Does Cost-Volume-Profit (CVP) Analysis Make?

The reliability of CVP lies in the assumptions it makes, including that the sales price and the fixed and variable cost per unit are constant. The costs are fixed within a specified production level. All units produced are assumed to be sold, and all fixed costs must be stable. Another assumption is all changes in expenses occur because of changes in activity level. Semi-variable expenses must be split between expense classifications using the high-low method, scatter plot, or statistical regression.

What Is Contribution Margin?

The contribution margin can be stated on a gross or per-unit basis. It represents the incremental money generated for each product/unit sold after deducting the variable portion of the firm's costs. Basically, it shows the portion of sales that helps to cover the company's fixed costs. Any remaining revenue left after covering fixed costs is the profit generated. So, for a business to be profitable, the contribution margin must exceed total fixed costs.

• Accounting History and Terminology 1 of 35
• Absorption Costing Explained, With Pros and Cons and Example 2 of 35
• What Is an Amortization Schedule? How to Calculate with Formula 3 of 35
• Average Collection Period Formula, How It Works, Example 4 of 35
• Bill of Lading: Meaning, Types, Example, and Purpose 5 of 35
• What Is a Cash Book? How Cash Books Work, With Examples 6 of 35
• Cost of Debt: What It Means and Formulas 7 of 35
• Cost of Equity Definition, Formula, and Example 8 of 35
• Cost-Volume-Profit (CVP) Analysis: What It Is and the Formula for Calculating It 9 of 35
• Current Account: Definition and What Influences It 10 of 35
• Days Payable Outstanding (DPO) Defined and How It's Calculated 11 of 35
• Depreciation: Definition and Types, With Calculation Examples 12 of 35
• Double-Declining Balance (DDB) Depreciation Method Definition With Formula 13 of 35
• EBITDA: Definition, Calculation Formulas, History, and Criticisms 14 of 35
• Economic Order Quantity: What Does It Mean and Who Is It Important For? 15 of 35
• 4 Factors of Production Explained With Examples 16 of 35
• Fiscal Year: What It Is and Advantages Over Calendar Year 17 of 35
• How a General Ledger Works With Double-Entry Accounting Along With Examples 18 of 35
• Just-in-Time (JIT): Definition, Example, and Pros & Cons 19 of 35
• Net Operating Loss (NOL): Definition and Carryforward Rules 20 of 35
• NRV: What Net Realizable Value Is and a Formula To Calculate It 21 of 35
• No-Shop Clause: Meaning, Examples and Exceptions 22 of 35
• Operating Costs Definition: Formula, Types, and Real-World Examples 23 of 35
• Operating Profit: How to Calculate, What It Tells You, and Example 24 of 35
• Production Costs: What They Are and How to Calculate Them 25 of 35
• What Is a Pro Forma Invoice? Required Information and Example 26 of 35
• Retained Earnings in Accounting and What They Can Tell You 27 of 35
• Revenue Recognition: What It Means in Accounting and the 5 Steps 28 of 35
• What Is a Sunk Cost—and the Sunk Cost Fallacy? 29 of 35
• Triple Bottom Line 30 of 35
• Variable Cost: What It Is and How to Calculate It 31 of 35
• Work-in-Progress (WIP) Definition With Examples 32 of 35
• Write-Offs: Understanding Different Types To Save on Taxes 33 of 35
• Year-Over-Year (YOY): What It Means, How It's Used in Finance 34 of 35
• Zero-Based Budgeting: What It Is and How to Use It 35 of 35

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Cost volume profit analysis

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