Cost Volume Profit Analysis for Non-Accounting managers.

A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this break-even point, a company will experience no income or loss. This break-even point can be an initial examination that precedes more detailed CVP analysis.

CVP analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are:

• The behavior of both costs and revenues are 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 product mix (the ratio of each product to total sales) will remain constant.

The components of CVP analysis are:

• Level or volume of activity.

• Unit selling prices

• Variable cost per unit

• Total fixed costs

• Manpower Cost Direct and indirect

The Margin of safety is the difference between the expected (or actual) sales level and the breakeven sales level. It can be expressed in the equation form as follows:

The Margin of Safety = Expected (or) Actual Sales Level (quantity or dollar amount) - Breakeven sales Level (quantity or dollar amount)

The measure is especially useful in situations where large portions of a company's sales are at risk, such as when they are tied up in a single customer contract that may be canceled.[