CVP stands for cost-volume-profit – three of the essential cornerstones of business. A CVP analysis is how you make sure your business is making money and work out the impact of production expenses and sales numbers on your earnings. Whether you’re a small business looking to scale up or a big business making sure you hit your monthly numbers, it’s vital that you understand what a CVP analysis is, how to run one and what to do with the information once you’ve got it.
What are the cost-volume-profit analysis formulas you need to know?
The key CVP formula is as follows: profit = revenue – costs. Of course, to be able to apply this formula, you need to know how to work out your revenue: (retail price x number of units). Plus, you need to know how to work out your costs: fixed costs + (unit variable cost x number of units).
Depending on what your goals are, you can also use additional formulas to help your CVP accounting along. For example, you can work out whether you’ve accurately priced your products by working out the contribution margin: revenue – variable costs. You can then convert that number into a percentage by dividing it by your revenue again and multiplying by 100. This gives you the contribution margin ratio or the profit-volume ratio.
Your costs ratio can also be used to work out your break-even sales units.
What is a cost-volume-profit analysis break-even point?
Your break-even point is the amount you need to make to ensure that you’re not losing money. It brings your net income to zero and shows the point at which your income matches your outgoings. You can work out your break-even point either in units or in pounds sterling. For your break-even point in units: fixed costs divided by contribution margin. For your break-even point in pound sterling: fixed costs divided by contribution margin ratio.
For many people, the easiest way to visualise this figure is by creating a cost-volume-profit graph.
What does a CVP graph look like?
The great thing about a CVP graph is that you can highlight the points and figures most important to your company.
Typically, you would plot unit numbers along your x-axis and pound sterling along your y-axis. From here, you can then highlight your fixed costs line and your variable costs.
At this point, you can chart your total costs and your total revenue. The point at which these intersect is your break-even point, which should be labelled on your graph. This provides a clear and easy visual representation of the amount you need to be selling to reach your target numbers.
When should you use CVP accounting?
Cost-volume-profit analysis can be a convenient tool when you’re considering changes in your company – whether that means introducing a new product, setting new targets, or weighing up your investments. It’s a simple and straightforward analysis that can be a useful starting point when you’re doing your calculations and may give you handy jumping-off points as you start to refine your plans. It’s also a handy tool for sharing with your stakeholders and, in particular, with your sales team.
The limitations of CVP analysis
A CVP analysis keeps calculations simple – but that means it has to make some assumptions upfront. For example, a CVP analysis assumes that all the units you produce will be sold and also assumes that your fixed and variable costs are constant. If you’re looking for a more accurate or tailored calculation, it’s worth doing some follow-up sums after you’ve reached your initial numbers.
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