Cost-Volume Profit Analysis

Cost-Volume-Profit (“CVP”) analysis is essential for any company to be able to determine break-even points, and determining short term decisions. Arguably, for small businesses, nothing could be more important, as CVP provides the minimum volume of a product needed to sell in order to experience neither a gain nor loss. For entrepreneurs it is important to be effective and efficient when utilizing CVP accounting processes. This provides the framework for analyzing CVP’s importance to entrepreneurs.
Defined, cost-volume-profit analysis is “the study of the effects of changes in cost and volume on profits” (Kimmel, 2011). CVP is critical in profit planning, determining selling prices, and helps determine the minimum number of future sales. Underling CVP are the assumptions that both cost and revenues are linear, costs can be classified as either fixed or variable, and one changes in activity or volume affect costs (Kimmel, 2011). CVP helps entrepreneur’s asses how much contribution is made on each product and how many units to sell in order to cover fixed costs. “[CVP] can [also] be used to determine whether efforts would be better directed toward the reduction of fixed costs or of variable costs” (Crowningshield, 1986).
Margin of Safety as it relates to cost-volume-profit measures the difference between actual sales and the break-even point. Margin of safety enables management to determine allowable sales risk when introducing new products. The margin of safety determines the amount that sales can decrease before breaking even or operating at a loss; this results in the estimated variance for a company’s sales relative to its break-even point. From an analysis standpoint, the larger the margin of safety, the greater the loss in sales an entrepreneur’s company can endure.
“The primary objective of [entrepreneurs] is