The Basic Profit Equation:
Cost-Volume-Profit analysis (CVP) relates the firm’s cost structure to sales volume and profitability. A formula that facilitates CVP analysis can be easily derived as follows:

Profit = Sales – Expenses

Profit = Sales – (Variable Costs + Fixed Costs)

Profit + Fixed Costs = Sales – Variable Costs

Profit + Fixed Costs = Units Sold x (Unit Sales Price – Unit Variable Cost)

This formula is henceforth called the Basic Profit Equation and is abbreviated:

P + FC = Q x (SP – VC)

Contribution margin is defined as

Sales – Variable Costs

The unit contribution margin is defined as

Unit Sales Price – Unit Variable Cost

Typically, the Basic Profit Equation is used to solve one equation in one unknown, where the unknown can be any of the elements of the equation. For example, given an understanding of the firm’s cost structure and an estimate of sales volume for the coming period, the equation predicts profits for the period. As another example, given the firm’s cost structure, the equation indicates the required sales volume Q to achieve a targeted level of profits P. If targeted profits are zero, the equation simplifies to

Q = FC ÷ Unit Contribution Margin

Q = FC ÷ Unit Contribution Margin

In this case, Q indicates the required sales volume to break even, and the exercise is called breakeven analysis.

Target Costing:
A relatively recent innovation in product planning and design is called target costing. In the context of the Basic Profit Equation, target costing sets a goal for profits, and solves for the unit variable cost required to achieve those profits. The design and manufacturing engineers are then assigned the task of building the product for a unit cost not to exceed the target. This approach differs from a more traditional product design approach, in which design