CVP analysis is used to check how changes in production volume affect costs and profits. It is a simplified form of break-even analysis, with limitations due to assumptions made, such as assuming every unit produced will be sold automatically.
CPV analysis is a system used to check how changes in production volume affect costs and therefore profits. It is an extended form of break-even analysis, which simply identifies the break-even point. The CVP analysis is somewhat simplified and is based on some assumptions that do not hold in reality, which means that it is better used for “big picture” analysis rather than a detailed examination.
Breakeven analysis takes into account the fact that production involves both fixed and variable costs. Fixed costs include machinery, factory real estate and, to some extent, marketing. Variable costs include labor and raw materials; more of these resources are used up as more products are produced. The break-even point is calculated as fixed costs divided by the contribution per unit. The per-unit subsidy is the price at which the firm sells the product, minus the specific variable costs associated with producing that single unit.
CVP analysis gets its name from cost, volume and profit. The associated analysis plots two lines on a graph with a horizontal axis showing the total number of units produced. The two rows represent total revenue and total cost for that number of units. In almost all cases, the entry line will start higher than the cost line, but climb at a steeper angle and eventually narrow the gap before breaking above the cost line and thus widening its lead. This represents increased sales which reduces losses, hits breakeven, and thus produces increasing profits.
There are several significant limitations to these figures that arise from simplified assumptions in the process. One obvious one is that it is assumed that every unit produced will be sold automatically. This is often not the case in reality, and the more units produced, the greater the risk of being left with unsold inventory.
Another problem with CVP analysis is that there is actually some crossover between fixed and variable costs. For example, the fixed cost of machinery will increase once it is running at full capacity and thus production will be increased. Meanwhile, variable costs don’t always vary exactly in line with production volume. A company may be able to increase production without increasing labor costs to the same extent if it can recover from some slack in its staff workload.
CVP analysis also has the limitation that it fails to account for all the ways in which the figures may vary. The selling price is treated as constant, but in the real world, increased sales may result in some buyers getting a bulk discount. Similarly, variable cost per unit may not be consistent, for example, if materials can be purchased in large quantities at a lower price.
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