Cost/Volume/Profit Analysis
To have a strong and successful business, you need to have a clear understanding of the financial impact that your most basic business decisions may have.
For example, do you know what your most profitable products or services are, so that you (or your salespeople) can really push those? Do you know what will happen if your sales volume drops? How far can it drop before you really start to eat red ink? If you lower your prices in order to sell more, how much more will you have to sell? If you take out a loan and your fixed costs rise because of the interest on the loan, what sales volume will you need to cover those increased costs?
Cost/volume/profit analysis can help you answer these, and many more, questions about your business operations. CVP analysis, as it is sometimes known, is a way of examining the relationship between your fixed and variable costs, your volume (in terms of units or in terms of dollars), and your profits.
There are three main tools offered by CVP analysis:
- breakeven analysis, which tells you the sales volume you need to break even, under different price or cost scenarios
- contribution margin analysis, which compares the profitability of different products, lines, or services you offer
- operating leverage, which examines the degree to which your business uses fixed costs, which magnifies your profits as sales increase, but also magnifies your losses as sales drop.
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