Cvp Analysis

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Date Submitted: 03/01/2009 06:50 PM

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Business is a lot like the human body. Money can be compared to blood, the accounting department can be compared to the heart and circulatory system, and the human resources department can be compared to the liver, cleaning out what the body (or company) doesn’t need. There is really no need to discuss what happens from there. But, as money is comparable to blood, there are things that feed the blood. Something like oxygen. And oxygen, while good for the body, is something that is often analyzed to make sure that there is the right mix to keep the blood adequately healthy. That analysis is to the body what cost-volume-profit analysis is to business.

Cost-volume-profit (CVP) analysis is the relationship between cost and profit between increased sales volume and expenses. Some costs (or expenses) don’t change at all. Some change by an increase or decrease by their activity. Much like a change in physical activity or a change in altitude affects oxygen levels, the increase or decrease in costs can literally kill a business. Fixed costs (like rent) rank with death and taxes as an expectation. Variable costs, an un-budgeted gas bill for instance, are not as easily anticipated. It is important for businesspeople to understand this idea, as even variable costs can have modifications. For instance, there are also semi variable costs. These costs increase at a steady rate per unit. An example that will most probably never be in a college textbook but is still a part of the college experience would be a drink and drown night at a local bar. Usually at these events a customer pays a cover charge (fixed rate) and pays a low cost (for this example, $1 per well drink) which increases the cost per night.

Barring alcohol references, though, CVP has many facets. Of these facets, contribution margin is important. Contribution margin is the amount of money left after subtracting variable costs. When unit selling prices increase, the contribution margin increases as well unless...