Cost-Volume-Profit Analysis & Income Statements

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• 0:04 Cost-Volume-Profit…
• 1:14 Components
• 2:20 Assumptions
• 2:46 CVP Income Statement
• 4:44 Lesson Summary
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Lesson Transcript
Instructor: Deborah Schell

Deborah teaches college Accounting and has a master's degree in Educational Technology.

Cost-volume-profit (CVP) analysis is one way for management to determine the relationship that exists between a company's costs, its revenue, and its sales volume. In this lesson, we'll take a look at how a restaurant might use CVP to look at its revenue.

Cost-Volume-Profit (CVP) Analysis

Mr. U. Grill is the new owner of the Burger Shack restaurant, which is known for its double-decker burgers and thick-cut fries. While the business is profitable, Mr. U. Grill has heard about CVP analysis and wonders if it would help him determine whether his current mix of product sales is the one that will generate the most profit for his business.

Cost-volume-profit (CVP) analysis is a tool that helps management determine the proper mix of products to maximize profit while taking costs and volume of sales into consideration. It also allows management to complete a 'what if', or sensitivity analysis, which illustrates the end result of changing a variable.

For example, let's assume that the Burger Shack wanted to raise the price of its double-decker burger by fifty cents. Completing a sensitivity analysis would show the impact of this change on sales volume and would allow management to make an informed decision about whether or not the price increase would increase company profit. Similarly, if Mr. U. Grill was thinking of changing to organic beef, a CVP analysis could help determine the changes that would need to be made to selling price or sales volume.

Components

There are five basic components involved in CVP analysis:

• The volume of activity of a product
• Unit selling price
• Variable cost per unit
• Fixed cost per unit
• The sales mix

Variable costs are costs that change with the amount of activity. Variable costs for the Burger Shack would include things like potatoes, ground beef, and the salaries of its employees. The more burgers and french fries the Burger Shack sells, the more potatoes and ground beef it will use, and the more employees it will have to hire to serve its customers.

Fixed costs are those costs that do not vary with the level of activity. The Burger Shack's monthly rent is an example of a fixed cost. It doesn't matter how many burgers it sells on a monthly basis; its rent will be the same.

The sales mix represents the mix of products or services that the company sells. For example, 50% of the Burger Shack's revenue (the money it generates from the sale of its products to consumers) might come from the sale of its burgers, 30% from french fries, and 20% from beverage sales.

Assumptions

To successfully use CVP analysis, we must make some assumptions. Specifically, we must assume that the costs incurred by the business can be easily classified as either variable or fixed. We must also assume that the only item that can affect cost is the volume of activity, and we must assume that all units produced by the business are sold to consumers. Finally, we must assume that the sales mix will remain constant.

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